How low can the U.S. unemployment rate go?

Determining the “natural rate of unemployment” in the U.S. labor market—the point at which nearly full employment is reached without sparking wage-driven inflation—is very much on the minds of economists today. The unemployment rate was 5.8 percent in October and the labor market has added an average of 229,000 jobs a month over the course of 2014, with unemployment down sharply from 7.2 percent in October 2013 and average gains in net jobs in 2013 of only 194,000 a month. Yet weaknesses still abound. The prime-age employment-to-population ratio is still 2.8 percentage points below its peak prior to the start of the Great Recession in December 2007. And long-term unemployment continues to be very high.

So just how healthy is the U.S. labor market? And how much more can policymakers, particularly those at the Federal Reserve, do to help increase employment without overheating the labor market?

The issue of the long-term unemployed is particularly important for determining where the natural rate of unemployment should be. Economists generally believe there is point at which the labor market is in equilibrium with inflationary pressures, hence that more technical name—the non-accelerating inflation rate of unemployment, or NAIRU for short. But how do the long-term unemployed factor into this specific rate of unemployment?

Many economists argue that the long-term unemployed are detached from the labor market. Workers unemployed for such a period shouldn’t be counted among those actively looking for a job. Doing so would make us believe the labor market is much weaker it actually is. Alan Krueger, a Princeton University economist and former Chair of the Council of Economic Advisers under President Obama, is a prominent proponent of this view.

On the other side of the debate, economists at the Federal Reserve Bank of New York released three blog posts this week arguing that the long-term unemployed are very much attached to the labor market. Rob Dent, Samuel Kapon, Fatih Karahan, Benjamin W. Pugsley, and Ayşegül Sahin find the long-term unemployed are very similar to the short-term unemployed in terms of demographics, have similar long-run labor market outcomes, and affect wage growth just as much as other unemployed workers.

So should economists include the long-term unemployed in our measures of labor market slack? And if so then, how low should we push the unemployment rate?

Matt Yglesias at Vox has a good rundown on the NAIRU concept, including the very-real possibility that there is no natural rate of unemployment. But as Jared Bernstein of the Center on Budget and Policy Priorities points out, making sure we don’t aim too high with this number is critical for running an economy at full employment.

What would happen to overall inflation, though, if wage growth did accelerate as the labor market heats up? Carola Binder, a PhD candidate at the University of California, Berkeley, summarizes the evidence and finds that the relationship between wage growth and overall inflation isn’t as strong as you might think.

The U.S. labor market today is clearly on the mend. Job growth is slower than we might expect after such a large recession, but it’s getting better. And recent evidence shows that there is room for improvement. After rolling the boulder so far up the hill, it’d be shame to stop now because of possible miscalculations of the status of the long-term unemployed and their effect on wage growth. After all, inflation today is one problem not in need of immediate attention.