There might be much less slack in the labor market than Janet Yellen thinks.
That's the prognosis offered by Stephen Williamson, vice president of the St. Louis Federal Reserve.
In a recent note, the economist examined different metrics that paint varying pictures of the U.S. labor market's strength.
One way to track how the job market is doing is by examining where the U.S. is on the Beveridge curve, which depicts the inverse relationship between job vacancy rates and unemployment rates. Since the financial crisis, this curve has moved to the right. That is, the job vacancy rate is higher than it was during the previous cycle, when the unemployment rate was close to 5 percent:
Williamson drew a connection between the elevated number of people who have been unemployed for 27 weeks or more—an unfortunate legacy of the Great Recession—and the rightward shift in the Beveridge Curve. This outcome is consistent with the view that there has been a growing mismatch between the skills available workers have and the ones companies want, he contended. That's one reason people have been unable to find jobs for so long.
Viewing the long-term unemployed as victims of structural change would have potential implications for Federal Reserve policy.
One way of reading the central bank's economic forecasts—which call for growth modestly above 2 percent though the projection horizon, inflation just shy of 2 percent, and the unemployment rate steady at 4.8 percent—is to infer robust labor force growth. (The alternative would be to assume a pickup in productivity). The demographic backdrop does not augur well for labor force growth of this magnitude; on the contrary, many economists are expecting payroll gains to moderate because of structural reasons.
Fed Chair Janet Yellen has proffered the view that a robust labor market could be a sufficient condition for "attracting discouraged workers back into the labor force."
As such, an implicit assumption embedded in the Fed's forecasts is that a meaningful amount of labor slack remains to be absorbed, whether from the long-term unemployed finding jobs or from people who have been out of the labor force (in some cases, after a stretch of unemployment lasting 27 weeks or more) electing to search for work.
The sticking point: There isn't much cause to believe that either will happen.
"Flows from unemployment to not in labor force tend to be positively correlated with the number of long-term unemployed," explained Williamson. "Basically, the long-term unemployed are relatively highly likely to drop out of the labor force."
The micro dynamics supporting this view are relatively straightforward: Employers prefer workers without large gaps in their résumés. The longer people go jobless, the less likely they are to find one, and it becomes more probable that they will give up looking for one. This suggests that this potential input to growth has been permanently lost, a dynamic known as hysteresis.
The unemployment rate would fall to 4.6 percent if the ranks of long-term unemployed were to fall to levels seen in 2007, with those people exiting the work force and all else holding equal, wrote Williamson. Unemployment currently stands at 5.1 percent.
If this segment of presumed would-be workers is unlikely to regain jobs, do people not in the labor force constitute a plentiful and viable source of untapped labor?
According to JP Morgan senior economist Robert Mellman, the answer is probably not. His research shows that flows into the labor force from outside it have not accelerated near the end of the last two expansions, notwithstanding an unemployment rate that was lower then than it is now.
"[W]hile it might seem logical to expect increased labor market entry during an expansion as the jobless rate declines and the job search gets easier, this has not been the case," wrote Mellman.
The financial crisis was not a typical post-war recession, so it stands to reason that some facets of the recovery differ from previous ones. Perhaps the prophesied cyclical rise in participation will come to pass.
Williamson's analysis, however, suggests it might be time to start thinking of the long-term unemployed as indicative of a lack—rather than exhibition—of slack, in which case the Fed has less work to do to fully achieve the "full employment" portion of its mandate.
"If we think of the long-term unemployed as being subject to the mismatch problem and highly likely to leave the labor force, then these unemployed workers are not contributing much to labor market slack," he wrote. "They are unlikely to be hired under any conditions."
This isn't the St. Louis Fed vice president's first controversial report.
Early this year, Williamson released a white paper (PDF) noting that no research "establishes a link from quantitative easing to the ultimate goals of the Fed—inflation and real economic activity," which questions the efficacy of the unconventional stimulus deployed in the wake of the Great Recession.
This more forward-looking assessment of how much progress the U.S. central bank needs to make before it can declare victory on one front, with obvious hawkish implications, will have a far better chance of shaping present-day monetary policy debates than Williamson's post-mortem of policies that have come and gone.