Yellen Watches American Paycheck for Signals on Shadow Slack

Federal Reserve Chair Janet Yellen is keeping a closer eye on the American paycheck these days.

The central bank chief referred to the “slow pace of growth” in measures of hourly compensation in remarks to the Senate yesterday as a sign of “significant slack” in labor markets.

The comments were significant because they suggest that even as the unemployment rate sinks, Yellen is examining how workers flowing back into the labor market -- the return of the so-called “shadow” labor supply -- could reduce the need for employers to offer higher wages. That would suppress inflation and allow the Fed to keep the benchmark interest rate low.

“You can’t have sustained inflation without sustained wage growth because then people have no purchasing power and higher prices just can’t stick,” said Aneta Markowska, chief U.S. economist at Societe Generale SA in New York. For Yellen, lack of wage growth is “proof of her thesis about plentiful slack in the labor market,” Markowska said.

Average hourly earnings were up 2 percent in June compared with a year earlier. Taking inflation into account, earnings were about flat for the year. In other words, income growth is simply not sufficient to sustain any mark-ups businesses may be trying to pass on to households.

Watching Closely

“There is some room there for faster growth in wages and for real wage gains before we need to worry that that’s creating overall inflationary pressure for the economy,” Yellen told the Senate Banking Committee yesterday, responding to a question from Senator Charles Schumer, a New York Democrat. “That’s something we are watching closely.”

The unemployment rate fell to 6.1 percent in June, a step closer to the 5.2 percent to 5.5 percent rate most Fed officials define as full employment.

The unemployment rate is calculated from the total labor force, which represents people who have jobs and those who are looking for work. The share of the working-age population who count themselves in the labor force stood at 62.8 percent in June, down from 65.7 percent when the recovery began in June 2009. Workforce participation was last around these lows in March 1978.

Yellen and her monetary policy committee are wrestling with question of how much of the decline in the labor force is permanent, the result of a retiring baby-boom generation, and how much represents people who quit looking for work. Those in the latter group could flow back in as job prospects improve and keep the participation rate from going any lower.

Yellen, who testifies before the House Financial Services Committee today, suggested that is exactly what she expects to happen.

Not Demographic

When men and women in their prime working years are leaving the labor force, that “suggests something that is not just demographic,” Yellen said in response to a question from Nebraska Republican Senator Mike Johanns following her semi-annual testimony.

“My personal view is that a portion of the decline in labor-force participation we’ve seen is a kind of hidden slack or unemployment,” she said. “It may be, if that’s correct, that as the labor market strengthens, that labor-force participation will remain flat instead of the demographic trend continuing to pull it down.”

Lower Longer

Fed officials said in their June statement they anticipate that, even as they close in on their 2 percent goal for inflation and their full employment estimate, the economy may “warrant keeping the target federal funds rate below levels” that the policy committee “views as normal in the longer run.”

Yellen reiterated that phrase in her testimony and added that “a high degree” of monetary accommodation remains appropriate.

U.S. central bankers have kept the benchmark lending rate in a range of zero to 0.25 percent since December 2008 and are indicating that they intend to keep their balance sheet, now at $4.38 trillion, at a high level even after they end bond purchases in October.

The statement language and Yellen’s comments are a departure from the pre-emptive inflation strike doctrine that prevailed at the Fed in the 1990s. The view then was that the Fed had to begin raising the benchmark rate early in anticipation of a cyclical rebound in prices.

The shift in the Fed’s views of inflation risks is appropriate because price-pressure trends in the U.S. have changed as companies can source both products and labor internationally, and also because of the huge overhang of underutilized workers, said Carl Tannenbaum, senior economist at Northern Trust Corp. in Chicago.

Marginally Attached

Some 2 million people were marginally attached to the labor force in June, meaning they wanted and were available for work yet had given up searching; those working part-time because they couldn’t find full-time work numbered 7.5 million. Those who have been jobless for six months or more count for about a third of the total unemployed.

Yellen, in a response to a question from Senator Sherrod Brown, an Ohio Democrat, spoke at length about the “exceptional psychological trauma” of being unemployed, especially for long periods of time.

Even though the unemployment rate is heading lower, “there is still work to be done before the Fed’s goal of full employment will be achieved,” Tannenbaum said.

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