Who bears the burden of labor-market slack?
Later this week, central bankers around the world will arrive in Jackson Hole, Wyoming for an economic policy symposium hosted by the Federal Reserve Bank of Kansas City. The confab is a closely watched meeting where big issues in the economy are discussed and hints about future Federal Reserve policy sometimes appear. This year the papers and presentations will center on changing labor market dynamics, an appropriate topic given the debate about slack in the U.S. labor market. As the economists and central bankers discuss the amount of untapped potential in the workforce, we should remember who pays the price for excessive slack: low-wage workers.
A recent paper by economists at the Chicago Fed is a good reminder of the real-life implications of slack. The authors, Daniel Aaronson and Andrew Jordan, look at the relationship between wage growth and measures of slack such as the unemployment rate. The paper has two main arguments.
The first is that the historical relationship between the unemployment rate and wage growth, known to economists as the wage Phillips curve, has broken down over the last 5 years. The large drop in the unemployment rate from 10 percent in 2009 to about 6 percent today has not been met with equivalent wage growth. The authors calculate that if the relationship hadn’t broken down, inflation-adjusted wage growth would have been 3.6 percentage points higher today.
The other key finding in the paper identifies the measures of labor market slack that are most strongly related to wage growth. Aaronson and Jordan find that the medium-term unemployment rate, or the share of the labor force unemployed between 5 to 26 weeks, as well as the share of the labor force working part time for economic reasons are strongly related to wage growth. Understanding which variables are the best indicators can help us understand how much slack there is in the labor market.
But while studies in this vein often look at growth in the average wage, the authors show the relationship for wage growth for low-wage workers (those at the 25th percentile of the income ladder) and high-wage workers (those at the 75th percentile). Importantly, they find changes in labor market slack have a much stronger relationship with wages for low-wage workers. A loose labor market will slow down wage growth for those at the bottom of the wage ladder far more than for workers at the top.
Looking at labor market dynamics in this way gives an increased urgency to understanding the amount of labor market slack. By tightening policy while slack still exists in the labor market, the Fed might very well slow down the economy unnecessarily for all Americans, but even more so for low-wage workers. The conversations at Jackson Hole will be all the more useful if that important reality is acknowledged and discussed.