Labor market slack: Has unemployment rate reached its long-run normal level? Cleveland Fed study
Estimates of labor market slack can differ greatly depending on how slack is defined, say Cleveland Fed researchers
But disparate slack estimates are currently close to one another, suggesting the unemployment rate has almost reached its longer-run normal level
Choosing the best measure of slack in the labor market depends on the question being asked, say Federal Reserve Bank of Cleveland researchers Murat Tasci and Randal Verbrugge, who note that different concepts of slack provide useful—but different—information.
Tasci and Verbrugge examine five recent approaches to measuring the longer-run normal level of the unemployment rate: looking at trends in labor market flows; creating a particular type of theoretical sticky-price model of the economy and then estimating it; unobserved components modeling; forecasting; and examining price or wage growth to determine the NIIRU (nonincreasing inflation rate of unemployment).
The researchers show that, at times, the differences in these estimates can be quite large. During the early 1980s, for example, estimates of the long-run normal level of the unemployment rate differed by as much as 4 percentage points, and there were similar divergences following the Great Recession. These differences translate into different implied estimates of labor market slack.
Has the unemployment rate reached its longer-run normal level? Tasci and Verbrugge say two of the concepts they discuss are potentially well-suited to this question: the labor-market-flows-based approach and the flexible-wage-counterfactual approach. The researchers show that, while estimates of the long-run unemployment rate corresponding to these concepts do not always agree, at present, they do agree. And both give essentially the same answer: “Almost.”
Tasci and Verbrugge note that since they have focused on the unemployment rate as their sole measure of the state of the labor market, they cannot claim to have shown that slack in the labor market has been eliminated. And even considering the unemployment rate alone, they found significant statistical uncertainty surrounding their estimates of slack. But the fact that each of the slack estimates yielded a significant forecast improvement at the two-year horizon implies that each conveys useful information, say the researchers. And the fact that these disparate slack estimates – which were constructed using a variety of underlying data sources – are now so close to one another is fairly strong evidence that the unemployment rate has nearly reached its long-run level.
And check out the interview with Cleveland Fed Vice President Bruce Fallick on his outlook for the long-term unemployed in the latest issue of Forefront.
Federal Reserve Bank of Cleveland
The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.
The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.
Doug Campbell, email@example.com, 513.455.4479