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The key question on US employment
As a keen student of unemployment, the nominee for the new Federal Reserve Chair Janet Yellen has been eager to make her thoughts clear on one of the biggest questions facing central banks, and in particular the Fed, namely whether the increase in US unemployment has become structural. In other words, are the unemployed losing their skills and becoming unemployable? This has important ramifications for US monetary policy, as if unemployment has a large structural, rather than cyclical component, inflation is more likely to be a problem and the Fed would have to tighten policy sooner than it would like.
The good news is that Yellen believes the increase in US unemployment is almost all cyclical and will fall back to its natural rate of around 5.5% as the economy normalises. She cites that job losses were widespread across economic sectors and that job openings have not been confined to a few sectors. Wage increases, though modest, are also spread across sectors meaning that no single part of the economy is experiencing unique tightness in its labour market. The implication for policy is that interest rates will indeed stay low for the foreseeable future and that tapering will probably now be delayed into 2014. This implies that 10 year Treasury bond yields will be capped around 3%, whereas the continued stimulus to the economy should ensure they do not fall beyond 2% again.
Yellen is not, however, a permanent dove. In the mid 1990s, she was arguing that unemployment had fallen too low and was urging her colleagues to watch for signs of excessive wage inflation. The Fed Chair is an important global role, and we are pleased that a pragmatist has been nominated.
