How much slack is left in the U.S. economy? How much of our resources are sitting around, factories idled and workers unemployed, almost five years after the recession? The answer is surprisingly unclear -- but it couldn’t matter more.
On one side are what you might call the “slackers,” including Federal Reserve Chair Janet Yellen and New York Times columnist and economist Paul Krugman. They say the U.S. has lots of room for growth before the economy returns to its full potential. Their opponents, who include San Francisco Fed President John Williams and some top New York Fed economists, say inflation may pick up soon because there is less slack than many expect.
The debate matters because estimates of the U.S. economy’s potential matter to economic policy -- and, if the guesses are off the mark, could hurt the actual economy. To cut off growth before that point would also slam the door on the unemployed, the slackers say. The Fed risks inflation if it overestimates that potential, slackers’ opponents reply.
Almost every technical debate among economic analysts at the moment is just one version or another of this slack issue. The current craze, for instance, is estimating how much of the decline in the percentage of people who say they’re working or looking for work -- 63 percent in 2014, down from 66 percent in 2007 -- is due to the recession (and so mostly reversible) and how much is due to demographic trends (and so mostly not reversible). Their effort hasn’t clarified the matter: Depending on who you ask, the change could be entirely demographic, mostly demographic, half demographic and half economic, mostly economic, or entirely economic.
The strongest piece of evidence is that far too many people are choosing to leave their jobs in search of better ones -- what economists dryly call “quits” -- for there to be much slack left in the economy and, in particular, in the labor market.
Why care about quits? Workers quit when they are confident they can find better work. They cling to a job, whatever job, when opportunities are scarce. Quits therefore capture a broader picture of labor-market tightness than can be measured directly by figures like the unemployment rate.
It’s often argued that unemployment, which has dropped sharply since the end of the recession, understates the amount of slack left. Many workers have stopped searching for work and so no longer count as “unemployed.” Yet quits say the unemployment rate has it right. They have risen by 800,000 a month since the worst part of the recession -- exactly the sort of progress you would expect if the unemployment rate were an accurate measure of labor-market tightness.
Now, here's the challenge for policy makers. The large number of quitters only makes sense if the long-term unemployed and the labor-force dropouts aren’t competing with them. The reason many now might feel empowered enough to quit, paradoxically, is because the recovery has left behind millions of others.
That theory matches the data, which show how full employment can exist alongside chronic joblessness. Even with long-term unemployment still sky-high, the share of workers who are unemployed for short periods of time is back to levels associated with a strong economy. That’s a sign that the job market is working for some even as it fails others -- and it’s this divide that creates a deep problem for policy.
In other words, the U.S. labor market seems to have split into two: one for the employed, where other work is relatively easy to find, and another for those scarred by joblessness, where work is scarce. If it has, then we have to redefine “full employment,” because the needs of the two labor markets conflict.
Quits would suggest the U.S. isn’t far from this revised definition of a tight labor market. The 6.7-percent unemployment rate, after all, is close to most estimates of unemployment’s natural level. That might call for a faster increase in interest rates over the next few years -- as it would mean current policy assumes too much slack. It’s a view that has gained ground recently with some Fed moderates, such as St. Louis Fed President James Bullard.
The litmus test for these dueling views is simple: Will we see wage growth pick up in 2014? If the employed are once again confident enough to quit, the next thing to expect is pressure on wages. Wages did begin to rise in 2013, according to several different measures. But not in any big way.
If wages don't increase, it means the slackers are right -- and, far more importantly, the economy won’t have lost the talents of millions of workers dying to prove their worth. Yet the risk that the slack is gone, and that it's time to start raising rates, seems more plausible than ever.
(Evan Soltas is a contributor to Bloomberg View. Follow him on Twitter at @esoltas.)
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