Slackers at the Fed

To taper or not to taper, that is the question. Except it’s actually two questions:

1. Are we getting close enough to “full employment” that it’s time to let up on the gas? How much slack is there in the economy, really?

2. To the extent that the economy still needs a boost, are purchases of long-term Treasuries the way to do this?

The answer to question 2 is probably no — but that’s an argument for replacing the current policy with something better, like purchases of MBS and/or stronger forward guidance, not for a taper all by itself, which serves as a sort of forward anti-guidance: it signals, whether the Fed intends this or not, a general shift toward hawkishness.

But what about question 1? The measured unemployment rate is down a lot — in fact, at 7.3 percent it’s almost exactly the same as it was in November 19821984, when Ronald Reagan won big on claims of restored prosperity. But most of the fall in unemployment reflects lower labor force participation rather than job growth. Even if we focus on prime-age workers, so as to net out demographic effects, the employment story is highly unimpressive:

The question is, how much should we look at the employment versus the unemployment numbers, which are telling different stories?

There’s no question that a weak economy tends to reduce labor force participation — people give up active searching for work when there are few jobs to be had. Jared Bernstein offers some clear cross-state evidence. On the other hand, you can make a case that there has been a secular downward trend in labor force participation, even age-adjusted; Gavyn Davies makes this case, and suggests that the unemployment rate may be a better guide than the employment ratio after all.

I can see Davies’s point. Here’s a picture of labor-force participation of prime-age adults since 2000, where I’ve separated pre- and post-crisis, and plotted the pre-crisis trend:

Looking at a picture like this, you could conclude that labor force participation isn’t all that depressed, after all.

So why don’t I believe it? One reason is that I suspect that the apparent downward trend in participation actually reflects differences in how boomy different booms have been. The US economy in 2000 had really, really full employment — it was an era when labor was so scarce that McDonald’s was actively trying to recruit senior citizens, when the joke was that you could get a job as long as your breath would fog a mirror, that is, as long as you were actually alive. The peak in 2007 was nothing like that. So what looks like a secular downward trend may in large part reflect instead the extent to which the “Bush boom”, such as it was, fell far short of the Clinton boom.

Still, there is some legitimate argument here. What I would say, however, is that the Fed needs to balance the risks here. Inflation is well below target — and there’s good reason to believe that the target is too low. There’s also good reason to believe that sustained high unemployment leaves lasting scars on the economy. Why not wait for clear evidence that the economy is really approaching capacity before doing anything that could be interpreted as tightening?