Yellen Adds Disadvantaged to Full-Employment Definition

The year was 1999, the unemployment rate was 4.3 percent, and President Bill Clinton’s top economic adviser had a message for economists gathered at Yale University: Tight labor markets are beneficial for blacks, Hispanics and male high-school dropouts.

The speaker was Janet Yellen, and she brings the same empathy for the disadvantaged to her current job as chair of the Federal Reserve. In her first 100 days, she has emphasized the central bank’s full-employment goal, stressing the need for progress on the broadest measures of joblessness, including the number of people out of work long-term and those who can find only part-time positions.

“This is a huge change -- a new definition,” said Allen Sinai, president of Decision Economics Inc. in New York, who has known five Fed chairmen personally in a Wall Street career spanning 40 years. “Yellen will be aggressive in the pursuit of full employment more broadly defined.”

The shift has created “some unprecedented tension” among investors, who must walk what Michael Hanson, U.S. senior economist for Bank of America in New York, calls Yellen’s “high-wire act” as the Fed gradually winds down the most aggressive stimulus campaign in its 100-year history.

Yellen, 67, wants labor markets to run hot to pull workers back in. At the same time, she has no tolerance for inflation persistently exceeding the Fed’s 2 percent target. She described the price goal as a “strong commitment” at the April 16 meeting of the Economic Club of New York, and the audience applauded.

Raise Rates

The Fed chair has had to learn that financial markets don’t appreciate nuance. When asked at her first press conference, on March 19, how long it would take to raise the benchmark federal funds rate after ending bond purchases, Yellen said bluntly: “around six months.”

She qualified that by saying it depends on how fast the Fed is moving toward its broader assessment of full employment, which it defines as joblessness of 5.2 percent to 5.6 percent. What’s more, she added, if inflation remains too low, there would be reason to hold the fed funds rate near zero for longer.

Still, yields on U.S. two-year notes jumped to 0.42 percent the day of her press conference from 0.35 the day before.

For now, investors are in line with the Fed’s go-slow approach on interest rates to boost job growth. Eurodollar futures price three-month interbank rates at about 2 percent by the end of 2016, below the Federal Open Market Committee’s 2.25 percent median estimate in March for the fed funds rate.

Surprising Strength

Analysts say the markets and the committee, the Fed panel that sets interest rates, could be surprised by the strength of the economy.

“We disagree with the market” and see it “as very vulnerable,” said Antulio Bomfim, a senior managing director at Macroeconomic Advisers LLC in Washington and former Fed economist. “We think even the committee is too low.”

Like her predecessors, Yellen is answering the economic challenge of her time. Paul Volcker tamed runaway inflation. Alan Greenspan introduced a systematic monetary policy that helped underpin the longest expansion in U.S. history. Ben S. Bernanke increased the Fed’s lending to save the financial system from collapse.

Much as Bernanke’s Great Depression scholarship was uniquely appropriate for the financial crisis, Yellen’s focus on jobs suits a period of slow growth and high unemployment. It’s also a time of widening disparities in income and wealth, trends she described as “very disturbing” in May 7 testimony to the Joint Economic Committee of Congress.

Lifting Burden

During a ceremony after she took office, she said the jobless rate represents “millions of individuals who are eager to work.” Every position that’s created “lifts this burden for someone who is better equipped to be a good parent, to build a stronger community.”

“She is trying to get more people engaged” in the work force, said Diane Swonk, chief economist at Mesirow Financial Holdings Inc. in Chicago. “It gets to the heart of what she really thinks is important: inclusion.”

Yellen was born in Brooklyn, New York, to parents who lived through the economic calamity of the 1930s, which was exacerbated by Fed policy errors.

“I was of a generation that still was affected by the Great Depression,” she said in a 2011 interview. “I didn’t live through it, but my parents grew up during it.”

‘Social Waste’

While her papers and speeches show intellectual reach -- from monetary-policy models to managing financial-system risk -- she’s had an abiding interest in labor markets: editing a book and writing papers on the topic with her economist husband, George Akerlof, a Nobel Prize winner, and calling unemployment “an extraordinarily costly social waste” in her April 1999 New Haven speech.

At the March 18-19 FOMC meeting, the first after she took office, she removed a pledge to keep the benchmark rate near zero at least as long as joblessness remained above 6.5 percent and inflation was forecast at no more than 2.5 percent.

“The committee has never felt that the unemployment rate is a sufficient statistic for the labor market,” she said at the press conference following the meeting. “It’s appropriate to look at many more things.”

She acted as the rate was poised to breach 6.5 percent this year, which it did in April, even as other labor measures she watches continued to show weakness.

With Yellen in charge, and the 6.5 percent threshold gone, the committee opted to maintain the go-slow approach to raising the fed funds rate that began under Bernanke. He pushed the cost of overnight loans among banks down almost to zero in December 2008 and kept it there through the rest of his tenure.

Full-Speed Economy

FOMC members in March forecast the fed funds rate would start rising in 2015 and end the year at 1 percent. They expected it to climb to just 2.25 percent in 2016, even as they achieve their goals of price stability and full employment. That would leave the benchmark almost 2 percentage points below the level they consider normal for an economy running at full speed.

Yellen, in her March press conference, said the committee for the first time endorsed the gradual rate path in its statement, which said economic conditions may “warrant keeping the target federal funds rate below levels the committee views as normal in the longer run.”

“I think that’s significant,” she said.

Roberto Perli, a former Fed board economist who is now a partner at Cornerstone Macro LP in Washington, said the slow pace is “unprecedented” in cycles of rising interest rates that he has studied going back to the 1970s. It “might be too shallow to be credible” as growth picks up, he said.

Unacceptable Trade-Off

“The Fed forecast is going to move” to better reflect the strength in the economy, Perli said. That’s so because Yellen “has said that we are not willing to trade off higher forecast inflation for higher employment.”

For now, she can afford to be patient. Inflation has run below the Fed’s 2 percent goal for almost two years, and the jobless rate has fallen to 6.3 percent, although it’s still “elevated,” she told the Joint Economic Committee.

The FOMC’s low median estimate for the fed funds rate is an expression of Yellen’s view that unemployment understates the degree of labor-market slack. If she’s right, the trigger point where strong demand for workers begins to push up wages and inflation may not show up as fast as economists expect.

One sign of that slack: the declining share of the working-age population either holding a job or looking for one. The so-called participation rate fell to 62.8 percent in April, almost a percentage point below where it was two years ago and matching the lowest since 1978.

Retiring Workers

Part of the drop reflects the growing number of workers entering retirement, “but I think some of it is because of a weak economy,” Yellen told the Joint Economic Committee. “That’s more slack, and that’s what we’re looking at and trying to judge.”

Yellen likes to remind investors that the Fed’s full-employment goal is about people, not numbers. In a March 31 Chicago speech, she told the stories of three who had trouble finding work. She omitted to mention that two of them had criminal records, exposing the Fed to criticism for “poor staff work or poor judgment,” in the words of Republican strategist Stuart Roy, founder of Strategic Action Public Affairs in Alexandria, Virginia.

While Yellen knew of the felony convictions, she decided to keep the people in her speech anyway.

“Janet has gone to great lengths -- some would say extremes -- to put a face on unemployment,” said Mesirow’s Swonk. “She understands it is not just numbers; it is the reality of what people see.”

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