Morning Must-Read: David G. Blanchflower and Adam S. Posen: Wages and Labor Market Slack: Making the Dual Mandate Operational

David G. Blanchflower and Adam S. Posen: Wages and Labor Market Slack: Making the Dual Mandate Operational: “We undertake the first econometric analysis…

…of the impact of rises in inactivity (1-LFPR) on wages in the US economy. To the degree that the rise in unemployment in the US is structural… wages should increase because of the negative shock to labor supply…. In contrast, if the rise in inactivity is largely cyclical, labor markets will see downward pressure on wages…. We find… inactives exert additional downward pressure on wages over and above the unemployment rate itself…. This pattern holds across recent decades in the US data, and the relationship strengthens in recent years when variation in participation increases. Our analysis is based on observations by state and year….

The implication… is two-fold. First, low participation is indeed an additional measure of labor market slack…. A substantial portion of those American workers who became inactive should… be expected to spring back into the labor market if demand rises to create jobs…. Second, wage inflation should be considered as the primary target of FOMC policy with respect to the employment stabilization side of the Fed’s dual mandate, at least for now…”