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Published on December 30th, 2014 | by admin

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Will Holding Down Rates Spark Inflation

Four years ago, 6.8 million Americans were out of work for six months or longer. Half as many are now. That might sound like good news, but it isn’t.

 Nearly four-fifths of those who became long-term unemployed during the worst period of the downturn have since migrated to the fringes of the job market, a recent study shows, rarely seeking work, taking part-time posts or bouncing between unsteady jobs. Only one in five, according to the study, has returned to lasting full-time work since 2008.

Fed officials face a conundrum: Should they keep trying to spur economic growth and hiring by holding short-term interest rates near zero, or will those low rates eventually spark inflation without helping those long out of work?

One school of thought, espoused by former Obama White House economic adviser Alan Krueger and some Fed researchers, sees the exodus as proof the pool of available labor is smaller than many think. If millions have drifted to the sidelines of the workforce, that would contribute to higher wage growth and greater inflationary pressure. The Labor Department reported Tuesday that consumer prices were up 2.1% in May from a year earlier, the biggest increase since late 2012.

The other view, embraced by Fed Chairwoman Janet Yellen and some other Fed economists, believes these millions can be drawn back into steady work if the economy strengthens. They thus represent a hidden supply of labor that will keep inflation down.

The first camp believes the Fed’s low-interest-rate policy has done about all it can to boost economic growth and help the long-term unemployed. The second camp believes the Fed still can prompt more job gains by keeping interest rates low.

If the first view proves right, the Fed may have to start raising interest rates to control inflation sooner than planned, a development that could jar stock and bond markets.

In a March Brookings Institution study, he and his coauthors found just 11% of people out of work for more than half a year had landed steady, full-time work within 15 months. Around a quarter had part-time jobs or had found and then lost full-time jobs. The rest, nearly two-thirds of the total, had given up seeking work or remained unemployed but still in the hunt.

“It’s going to take a different set of tools” to help the long-term unemployed, Mr. Krueger said in an interview.

Ms. Yellen, who cut her teeth in labor economics as an academic, isn’t buying that argument.

The Fed is winding down a bond-purchase program meant to stimulate growth while slowly turning to the question of when to raise short-term interest rates, which could affect household and business borrowing costs. Fed officials have said they don’t expect to raise rates until next year, and their thinking about long-term unemployment plays a central role in that calculation.

Ms. Yellen has immersed herself in details of the long-term unemployment debate, devouring research on the subject. She also has shown an interest in the individual hardships associated with the problem.

In March she spent more than an hour on the phone with several Illinois residents suffering from long unemployment spells. She highlighted them in a speech, noting the stigma of being out of work for years and how some employers have turned it into “a disqualification.”

With unemployment so high for so long, why didn’t inflation fall more?

In his March paper, Mr. Krueger argued inflation hasn’t been responsive to the long-term unemployed because they are so detached from the labor force.

The low rate of inflation, he said, tracked more closely with the fortunes of people out of work for short durations and still engaged in the day-to-day churn of résumé writing, interviewing and job searching. In May, 6.4 million Americans were out of work for less than 27 weeks, in line with prerecession levels.

Other economists came to the same conclusion independently, including Princeton University Professor Mark Watson, Northwestern economist Robert Gordon and researchers at the Federal Reserve Bank of New York. The White House advanced the idea, too, noting in its March release of the Economic Report of the President that large numbers of “short-term unemployed put more downward pressure on wages.”

Mr. Krueger says other policies that aren’t the Fed’s purview, such as tax credits for employers hiring long-term unemployed and government-funded job-search assistance, are needed to address the problem.

If he is right, the Fed has potentially done about as much as it can do to help them. Mr. Krueger said he doesn’t think inflation is yet a serious threat and isn’t calling for rate hikes, but he added the Fed “should be aware of the limits of monetary policy.”

Economists at the Federal Reserve Board in Washington have produced a series of papers contradicting Mr. Krueger’s conclusions and pointing out what they view as flaws in his and other research.

Some say the recent period of high long-term unemployment is so out of the ordinary that it is impossible to draw clear conclusions about its effect on inflation. Short- and long-term unemployment typically move in lock step, making it hard to tease out differences in their effects.

Mr. Krueger, who sparred with Fed researchers in the past over their work on the minimum wage, said broadly of Fed staff economists: “They have a lot of talent, but labor economics has not been their strength.”

Some Fed officials say Mr. Krueger’s own research isn’t holding up. Revisions to his March paper could draw less concrete conclusions about the connection between unemployment and inflation than before. A revised paper he shared with The Wall Street Journal deleted a section on the Phillips curve which addressed this interplay. He said he planned to break it out into a separate paper.

Ms. Yellen said in testimony to Congress in May she believed that as the economy strengthens, people who have been unemployed for long stretches will be drawn back into the job market, probably among the last to benefit from an economic expansio


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