By Lee Cary
Janet Yellen’s August 22, 2014 speech at the Federal Reserve Bank of Kansas City Economic Symposium held in Jackson Hole, Wyoming was a verbal shell game with an invisible pea.
The first paragraph in Yellen’s speech began with this sentence: “In the five years since the end of the Great Recession, the economy has made considerable progress in recovering from the largest and most sustained loss of employment in the United States since the Great Depression.”
Then, the first paragraph ended with the admission that “…five years after the end of the recession, the labor market has yet to fully recover.”
Many of the remaining 3,450 words she spoke refuted the claim of “considerable progress” and turned over multiple shells in search of the pea that explains why the labor market has not “fully” recovered.
The pea remains invisible.
In her penultimate paragraph, Yellen stated that, although labor market conditions have “improved more rapidly [rapid after five years?] than the Committee [Federal Open Market Committee, or FOMC] had anticipated,” “Of course, if economic performance turns out to be disappointing and progress toward our goals proceeds more slowly than we expect, the future path of interest rates likely would be more accommodative [read “lower”] than we currently anticipate.”
Throughout her speech, Yellen used “if,” “might,” “may,” and “could” a total of 58 times. (The saying, “If my aunt had a moustache, she’d be my uncle” is only disputed by those with aunts who have moustaches.)
FED policy going forward is dependent on finding the pea that will drive the maximum employment goal. Here’s a sampling of Yellen’s ruminations on that search:
- “Judgments concerning the size of that gap [between employment numbers today and “maximum employment”] are complicated by ongoing shifts in the structure of the labor market and the possibility that the severe recession caused persistent changes in the labor market’s functioning.” (Translation: The recession may have fundamentally changed things much more than we thought.)
- “…our understanding of labor market developments and their potential implications for inflation will remain far from perfect,” as monetary policy reflects “our ever-evolving understanding of the economy.” (Translation: We’re making this up as we go.)
- “Differing interpretations of these developments [related to the functioning of the labor market] affect judgments concerning the appropriate path of monetary policy.” (Translation: Due to circumstances we don’t understand, we are somewhat befuddled as to where to go from here.)
- “As the recovery progresses, assessments of the degree of remaining slack [measured in the employment number today vs. the maximum employment that will enable a loosening of the FED’s “highly accommodative monetary policy”] in the labor market need to become more nuanced because of considerable uncertainty about the level of employment consistent with the Federal Reserve’s dual mandate [“of maximum employment and stable prices,” meaning low inflation].” (Translation: The FED’s “Nuanced” assessments – “nuance” from the Latin word for “cloud” – are too esoteric for common folk to understand.)
- “In 2012…the FOMC explicitly recognized that factors determining maximum employment ‘may change over time and may not be directly measurable,’ and that assessments of the level of maximum employment ‘are necessarily uncertain and subject to revision.’” (Translation: We’ve known for some time that we’re driving in the dark without lights.)
- “The assessment of labor market slack is rarely simple and has been especially challenging recently. Estimates of slack necessitate difficult judgments about the magnitudes of the cyclical and structural influences affecting labor market variables, including labor force participation, the extent of part-time employment for economic reasons, and labor market flows, such as the pace of hires and quits. A considerable body of research suggests that the behavior of these and other labor market variables has changed since the Great Recession. Along with cyclical influences, significant structural factors have affected the labor market, including the aging of the workforce and other demographic trends, possible changes in the underlying degree of dynamism in the labor market, and the phenomenon of “polarization”–that is, the reduction in the relative number of middle-skill jobs.” (Translation: Our work is so hard! The labor market has changed since the “Great Recession” – possibly significantly – and all things are possible for us Central Planners who don’t know all things.)
- “Consider…the behavior of the labor force participation rate, which has declined substantially since the end of the recession even as the unemployment rate has fallen. As a consequence, the employment-to-population ratio has increased far less over the past several years than the unemployment rate alone would indicate, based on past experience. For policymakers, the key question is: What portion of the decline in labor force participation reflects structural shifts and what portion reflects cyclical weakness in the labor market? If the cyclical component is abnormally large, relative to the unemployment rate, then it might be seen as an additional contributor to labor market slack. (Translation: We don’t really know how to read the unemployment numbers today. It is a riddle, wrapped in a mystery, inside an enigma; but perhaps there is a key under one of the shells we’re searching. Unfortunately, we haven’t found it yet. Credit Winston Churchill, Oct. 1939)
- “…the drop in the [labor market] participation rate since 2008 can be attributed to increases in four factors: retirement, disability, school enrollment, and other reasons, including worker discouragement. Of these, greater worker discouragement is most directly the result of a weak labor market, so we could reasonably expect further increases in labor demand to pull a sizable share of discouraged workers back into the workforce. Indeed, the flattening out of the labor force participation rate since late last year could partly reflect discouraged workers rejoining the labor force in response to the significant improvements that we have seen in labor market conditions. If so, the cyclical shortfall in labor force participation may have diminished. (Translation: Just about anything could have caused the labor participation rate to drop. We ruminate on possible causes, but we really don’t know what we don’t know. Oops! Did I just say “weak labor market?”)
- “Disability applications and educational enrollments typically are affected by cyclical factors, and existing evidence suggests that the elevated levels of both may partly reflect perceptions of poor job prospects.” (Translation: We think some people claim disability benefits and others stay in school because of the poor job prospects. Oh! Did I just say “poor job prospects?”)
- “At nearly 5 percent of the labor force, the number of such workers [with part-time jobs] is notably larger, relative to the unemployment rate, than has been typical historically, providing another reason why the current level of the unemployment rate may understate the amount of remaining slack in the labor market.” (Translation: The number of part-time workers counted among the “employed” makes us even more skeptical about the value of the official unemployment rate.)
- “Given the rise in job vacancies, hiring may be poised to pick up, but the failure of hiring to rise with vacancies could also indicate that firms perceive the prospects for economic growth as still insufficient to justify adding to payrolls. Alternatively, subdued hiring could indicate that firms are encountering difficulties in finding qualified job applicants…Indeed, these flows may provide evidence of reduced labor market dynamism, which could prove quite persistent.” (Translation: The job market isn’t advancing as we’d hoped, and that’s not good. And it’s even worse if it persists – that’s bad dynamism.”)
- The Buried Admission: “[T]he decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.” (Translation: We question the accuracy of the current employment numbers, but don’t ask us to define “somewhat.” We’re somewhat vague about…somewhat. )
That takes us a little over halfway through Yellen’s speech. Before she finishes, she deploys a disputed Keynesian hobby horse built on the Phillips Curve.
- “First, the sluggish pace of nominal and real wage growth in recent years may reflect the phenomenon of “pent-up wage deflation.” The evidence suggests that many firms faced significant constraints in lowering compensation during the recession and the earlier part of the recovery because of “downward nominal wage rigidity”–namely, an inability or unwillingness on the part of firms to cut nominal wages. To the extent that firms faced limits in reducing real and nominal wages when the labor market was exceptionally weak, they may find that now they do not need to raise wages to attract qualified workers. (Translation: The value of wages isn’t being decreased by inflation – since there is little inflation in the Yellen worldview. Consequently, she believes employers are under no pressure to raise wages, particularly since jobs are at a premium.)
Andre Atkeson and Lee E. Ohanian, Visiting Scholars, Research Department, Federal Reserve Bank of Minneapolis, and Professors in the Department of Economics at the University of California, Los Angeles, authored “Are Phillips Curves useful for Forecasting Inflation?” They answered “No.”
In their 2001 paper they state:
“As argued by Friedman (1969), Lucas (1972), Fischer (1977), and Taylor (1980), among others, economic theory does not predict a stable and systematic relationship between current unemployment and future inflation. Instead, theory predicts that observed relationships between these variables should change with changes in agents’ expectations of inflation. Since theory predicts that agents’ expectations of inflation should vary as the economic environment changes, theory predicts that any relationship between current unemployment and future inflation observed in historical data should be expected to change as the economic environment changes. Thus, there is no theoretical presumption that a statistical relationship observed in one economic environment would be stable enough to be useful for forecasting inflation when that economic environment changes.”
“[W]e think that any inflation forecasting model based on some hypothesized economic relationship cannot be considered a useful guide for policy if its forecasts are no more accurate than such a simple atheoretical forecast. Our results contrast sharply with the conventional wisdom. We find that over the last 15 years, all three sets of NAIRU [non-accelerating inflation rate of unemployment] Phillips curve-based inflation forecasts have been no more accurate than the forecast from our naive model, that inflation over the next year will be equal to inflation over the previous year. We conclude that NAIRU Phillips curves are not useful for forecasting inflation.” (Highlighting added.)
Conclusion: FED Chair Janet Yellen’s recent speech gave us a glimpse behind the curtain that conceals the FED’s Wizards of Smart.
It stimulated Wall Street, smelling more money flowing from the FED pump.
But it did not provoke noteworthy confidence on Main Street.
In the Wizard of Oz, Dorothy said to the Wizard, “I think you are a very bad man.”
And the Wizard replied, “Oh, no, my dear; I’m really a very good man, but I’m a very bad Wizard, I must admit.”