Federal Reserve Chairman Alan Greenspan revealed an interesting statistical tidbit in his recent testimony on the Fed’s semiannual Monetary Policy Report to the Congress.
The chairman appeared before the House Committee on Financial Services on July 20 and before the Senate Banking Committee on July 21. On both days he was questioned about a recent public policy brief from the Boston Federal Reserve Bank that had been featured in a New York Times op-ed article.
The Boston Fed’s brief examined the incomplete recovery in labor force participation in the current economic expansion and concluded that the labor force shortfall today ranges from 1.6 million to 5.1 million. The addition of these hypothetical participants to officially measured unemployment, according to the brief, “would raise the unemployment rate by 1 to 3-plus percentage points.”
These estimates would boost the current 5 percent unemployment rate to a low of 6 percent up to a deep recession level of 8 plus percent.
It was an awkward moment for the chairman, and he replied as diplomatically as possible under the circumstances, saying “Certain calculations that were made at the Boston Fed inadequately captured what was going on.”
The main shortcoming in the Boston Fed analysis was it made inadequate allowance for structural or trend influences on labor force participation as opposed to cyclical effects. (Examples of long-term factors dampening the trend in total labor force participation include aging of the labor force and a halt in the secular rise in participation rates of nonelderly adult women.) While the Boston Fed’s upper-end estimate of the labor force shortfall looks to be exaggerated, its lower bound is not inconsistent with independent estimates.
Mr. Greenspan said the Federal Reserve Board’s estimate of the labor force shortfall was “less than a half percentage point.” That’s the interesting statistic he revealed, which probably would not have been disclosed had it not been for the publicity given the Boston Fed’s numbers and the need for clarification.
From this we can presume the Fed’s estimate of the cyclical shortfall (sometimes called the labor reserve or hidden unemployment) is only a 0.3 or 0.4 percentage point addition to the official unemployment count, which translates to about 450,000 to 600,000 uncounted jobless on the sidelines.
If the Boston Fed’s upper range estimate is too high, the Federal Reserve Board’s is a low-ball estimate, equivalent to a few months of the average employment increase thus far this year. However, even solid methodologies will produce different numbers, given the difficulties in measuring labor force slack.
The labor participation rate was high and flat during the noninflationary high employment period from late 1996 to early 2001, averaging slightly more than 67 percent. Its pre-recession cyclical peak was 67.2 percent in March 2001. It’s now 66 percent.
A 67.2 percent rate at the current level of employment would amount to a 2.7 million labor reserve, equal to a 1.7 percentage point increase in the unemployment rate. This is not an unreasonable upper limit, though it needs to be reduced somewhat to account for structural changes that have put downward pressure on labor force participation in recent years.
The Greenspan estimate did that. Indeed, it probably overdid it. The Fed estimate amounts to only a small part of the crude (mixed trend-cycle) participation-rate shortfall, which suggests the great part of the gap is structural rather than cyclical. That’s doubtful. By my calculation a more reasonable estimate would add about a percentage point to the unemployment rate.
Despite ongoing structural changes in the labor force, the Bureau of Labor Statistics projects a slightly rising trend in the overall participation rate to 2012.
The Fed chairman’s estimate implies there is not much slack left in the economy’s labor reserve outside the work force. Within the labor force, the unemployment rate of active job seekers has declined from a post-recession high of 6.3 percent in June 2003 to 5 percent today. By the reckoning of some economists, a 5 percent jobless rate is equal to or within striking distance of full employment.
Mr. Greenspan did not say in his testimony what unemployment rate he believes is consistent with full employment today. But if his views on the amount of cyclical slack in officially measured unemployment are consistent his low-ball estimate of cyclical slack outside the labor force, full employment by Fed thinking is not far away.
In his prepared statement Mr. Greenspan noted that “slack in labor and product markets has continued to decline” and “future price performance will be influenced importantly by the trend in unit labor costs.”
Unit labor costs have been rising in recent quarters, and the implication of a thin cushion of available labor resources suggests additional wage-price pressures may build faster than markets have anticipated. Consequently, the Fed may lean a little longer or a little harder on the inflation brakes.
Estimates of labor force slack are critical for monetary policy, and in that department it’s what Chairman Greenspan and his colleagues believe that counts. But before acting it might be a good idea if they took a harder look at their numbers.
Alfred Tella is former Georgetown University research professor of economics.