Slack, Employment, and Inflation By: Gabriel PotterMBA, AIFA® 2014.08.25

Federal Reserve president Atlanta Lockhart was on CNBC recapping the latest Federal Reserve report from Jackson Hole, Wyoming. We found his comments interesting for a variety of reasons. First, per our February 2012 article, we note the expanded communication from the Federal Reserve and greater transparency from the individual governors. We are particularly impressed that Fed governors are allowed to disagree publicly with the ruling from the Fed Chair, Janet Yellen. Second, given the Federal Reserve’s dual mandate of full employment and price stability, the governors seem concerned about the lack of inflation given the incredible recovery in jobs. Unemployment has dipped to 6% - a six year log - and labor costs are the primary determinant of inflation, so how has inflation stayed so low for so long?

Fed Chair Yellen answered this question by discussing the “slack” in the labor market, leading to no appreciable inflation despite the 0% interest rates. What does she mean by this?

The unemployment rate doesn't explain the whole picture. Relative to the employment situation before the financial crisis, the replacement jobs aren't growing wages at the same pace. Further, there is still an overhang from the shadow unemployment rolls (i.e. low labor participation rates); those people are not included in the unemployment calculation. In other words, unemployment can be low because of a number of discouraged people not looking for work, and baby boomers accepting early and sub-par retirement.  Finally, the jobs that have been created since 2008 are disproportionately part-time jobs in low wage industries. This slack in the labor market encourages the Fed to remain accommodative, without fear of imminent price increases.


Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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