Labor market slack
Some economists have argued that the labor market slack (the situation of worker oversupply) remains smaller than suggested by the current unemployment rate of 6.3%. They argue that the amount of short-term unemployed people (workers unemployed for less than 27 weeks) has returned close to its long-term average and that it’s the short-term unemployment level that drives compensation trends.
In his speech, Dr. William Dudley undermined that conclusion, saying that the “relative impact of each type of unemployment on wages depends on whether long-term unemployment reflects primarily structural or cyclical forces.” If a person has remained unemployed because they lack necessary skills, this is a structural issue that monetary policy can’t solve. In this case, a long-term unemployed person may not boost labor supply and exert downward pressure on wages, as they’re not really meeting labor demand. On the other hand, if a person has remained unemployed for a prolonged period because they lost a job during the recession, they are simply “unlucky.” In these cases, the extent of pressure these “unlucky” people can put on wages depends on whether there’s an excess supply of short-term unemployed people.
Employers are generally biased in favor of short-term unemployed people. To put this in simple terms, employers prefer to hire a short-term unemployed person over a long-term unemployed person, all else being equal. So, if there are plenty of short-term unemployed people, they may get the job first, undermining the impact of long-term unemployment on wages. As the economy improves, the supply of short-term unemployed people erodes, increasing the impact of long-term unemployed people on wages as they become more relevant to labor market supply.
As the economy improves, labor market slack will contract. More people will have jobs and, in turn, higher disposable incomes. Higher disposable incomes can drive demand for housing and home improvements, cars, and other discretionary products, helping companies like Home Depot (HD), Ford (F), and General Motors (GM). On the other hand, policymakers worry about inflationary pressure arising out of an improving economy. They would in turn increase interest rates, hampering bonds (BND)—and especially Treasury bonds (TLT).
Dudley went on in his speech to explain the outlook for monetary policy and the new monetary policy tools the Fed’s experimenting with. Find out more in this Market Realist series.