The Associated Press

The Fed Must Continue to Fight Unemployment

Janet Yellen is right to support keeping interest rates low in order to combat high unemployment.

The Associated Press

Federal Reserve Chair Janet Yellen.

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“The recovery in the labor market is far from complete,” the new Federal Reserve chairwoman, Janet Yellen, told Congress this week, adding that we shouldn’t expect the Fed to begin raising interest rates any time soon. Here’s why she’s right:

The Fed has a dual mandate from Congress to pursue maximum employment and price stability. When unemployment is high and inflation low, the Fed should keep interest rates low and adopt other necessary measures to, as Yellen told lawmakers, create “financial conditions [that] support consumer spending, business investment, and housing construction, adding impetus to the recovery.” That’s where we’ve been since the 2008 economic and financial crisis, which quickly turned a normal downturn into the Great Recession. The painful legacy of that trauma remains evident in today’s labor market.

[See a collection of political cartoons on the economy.]

Let’s start with unemployment. The chart below shows the path of unemployment after the start of the recovery from each of the last four major recessions. In the current recovery (the red line), the unemployment rate has dropped substantially and now stands at 6.6 percent. But it remains higher than at this point in any previous recovery and well above where it was before the recession.

As Yellen testified, 

The unemployment rate is still well above levels that [we monetary policymakers] estimate is consistent with maximum sustainable employment.

[See a collection of political cartoons on the budget and deficit.]

More disturbing, the fall in unemployment has not been accompanied by gains in employment. Instead, the workforce has shrunk as a share of the population as people have left in discouragement or stayed away entirely because job prospects remain so discouraging. Due to that declining labor force participation and high unemployment, the share of the population with a job, which plunged in the recession to rates last seen in the early 1980s, has barely risen since then (see chart). To be sure, the share of the population that would have a job in a normal labor market is falling as baby boomers age into retirement, but a substantial part of the current low level reflects an abnormally weak labor market not demography.

Yellen notes two other disturbing indicators: abnormally high long-term unemployment and the large number of people who are working in part-time jobs but really want full-time work. As the chart below shows, the share of the unemployed who have been looking for work for 27 weeks or more has dropped below its peak of over 40 percent but remains substantially higher than at any time in the six decades before the Great Recession. 

[See a collection of political cartoons on Congress.]

The long-term unemployment rate has fallen from over 4 percent. But it remains closer to its highest peak before the Great Recession (in the 1980s) than to what it would be in a normal labor market.

Besides the official unemployment rate, which counts people as unemployed only if they’ve recently been looking for work, the Bureau of Labor Statistics publishes other measures of labor underutilization. Its most comprehensive alternative measure – which includes people who want to work but haven’t looked recently and people working part time because they can’t find full-time work – was 12.7 percent in January and has not declined to the same degree as the official rate. By that alternative measure, about 20 million people are unemployed or underemployed.

[See a collection of political cartoons on defense spending.]

As for inflation, Yellen noted that it ran well below the Fed’s 2 percent target last year. And while Fed policymakers expect it to eventually move back to 2 percent, they will continue to keep monetary policy very “accommodative ... well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the 2 percent goal.”
Fed critics in and out of Congress have been predicting from the git-go that the Fed’s extraordinary measures to combat the financial crisis and Great Recession – the large-scale asset purchases know as quantitative easing or QE – were a ticking inflationary time bomb. Like the 1897 report of Mark Twain’s death, however, those claims are “an exaggeration” that should not interference with efforts to restore a healthy labor market.