Labor market predominates again in deciphering extent of recovery


Dec. 4 2020, Updated 10:53 a.m. ET

Yellen’s take on the labor market “slack”

Janet Yellen spoke on monetary policy and forward guidance at The Economic Club of New York on Wednesday, April 16. In the last section, we discussed the Fed’s outlook for the economy. In this part, we will discuss Janet Yellen’s views on labor market slack, one of the “three broad questions” posed by the Fed Chair, the answers to which are likely to shape the future monetary policy.

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Labor market “slack” refers to a situation in the economy when there are more workers than jobs, implying a less-than-optimal state in the labor market. The Fed Chair, Janet Yellen in her speech to The Economic Club implied that as there was evidence of labor market slack in the U.S. economy; monetary policy would continue to be accommodative, until the situation was reversed.

This means, the main Fed tool, that is, the Fed funds rate, which has hovered at the unprecedented lows of 0% to 0.25% since December 2008, will continue in this range, until signs of improvement are visible in the labor market. By keeping the Fed funds rate low, the Fed hopes that businesses are incentivized to borrow and invest the funds in new projects, which would create employment in the economy.

For more on the views of the other Fed officials on the Fed funds rate and employment, read the Market Realist series, Why the Fed’s delinking unemployment from the taper affects ETFs.

In assessing the labor market improvement, Yellen said that the unemployment rate remained the single best measure. “At 6.7%, it is now slightly more than one percentage point above the 5.2-5.6 percent central tendency of the Committee’s projections for the longer-run normal unemployment rate. This shortfall remains significant, and in our baseline outlook, it will take more than two years to close,” she said.

The unemployment rate has fallen faster than the policy-makers had expected, primarily due to the discouraged workers giving up on their job hunt, which has lowered the labor force participation rate.

Yellen also said that in assessing labor market slack, other, broader, labor market measures might be more appropriate. Some of the measures she discussed were:

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  • The percentage of workers who were forced to work part-time (due to lack of openings) but would prefer full-time jobs “remains quite high by historical standards.” This percentage was only 3% prior to the recession and reached a peak of 5% in November 2009. Currently it stands at ~5%.
  • Long-term unemployment measured by persons looking for work for more than six months, currently stands at just under 2.5%, still way above the pre-recession level of ~1%. This had reached a peak of 4.5% in 2010.
  • Labor force participation continued to decline during the recovery and has only just shown signs of improvement. While part of this decline may be due to an aging baby-boomer population, which may never rejoin the labor force, Yellen believes part of it could be due to labor market slack.
  • Wage gains “continue to proceed at a historically slow pace in this recovery, with few signs of a broad-based acceleration.”

She said the Fed would take these factors into account in determining whether any monetary policy adjustments were required.

The following parts will discuss the other two questions posed by Fed Chair, Janet Yellen and their impact on monetary policy. We will also analyze the impact of current economic conditions on cyclical industries (XLY) including companies like Ford (F) and General Motors (GM), and ETFs like the ProShares Short 7-10 Year Treasury Fund (TBX) and the Barclays iPath US Treasury 10-Year Bear ETN (DTYS).


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