Janet Yellen is getting the wrong message from a stubborn soft spot in the job market

  • Fed officials are convinced labour force participation declining due to an ageing workforce
  • Data showing rises in participation for minorities suggest the Fed is wrong
  • Keeping rates low for longer could help more Americans return to labour market

The Federal Reserve isn’t giving American workers enough credit.

At first, most Fed officials viewed the steep post-recession slump in US workforce participation as a reflection of the downturn and its severity, something that would reverse with time and the help of low interest rates. With time, many including Fed Chair Janet Yellen have become convinced long-run demographic factors like the retirement of ageing baby boomers, less amenable to redress from monetary policy, are primarily to blame.

However, a recent rise in the participation rates of black and Hispanic workers, who are disproportionately hurt during economic downturns, suggests Fed officials are wrong. Instead, the gains suggest the low unemployment rate is encouraging new workers to come back into the workforce, a positive trend the Fed should reinforce rather than restrain by raising interest rates further.

A shrunken US workforce, now close to its smallest size since the 1970s, is at the center of the debate over just how strong the labour market is. Understanding the causes of this decline helps Federal Reserve officials gauge how much room they have to keep interest rates low for a while longer, after an eight-year recovery that’s on track to be both the longest and weakest on record.

True, overall participation has been stuck at multi-decade lows for several years, hovering just below 63%. But black and Hispanic participation have shown distinct gains over the last couple of years, as the labour market tightened further. This suggests any effort by the Fed to prematurely tighten financial conditions could come at the expense of more and higher paying jobs for lower-income Americans.

One paper held particular sway at the consensus-driven central bank in driving the demographics story of labour force decline, said Danny Blanchflower, a former Bank of England official now at Dartmouth College, in a recent interview with Business Insider. Published in 2014, it claimed that “much — but not all — of the decline in the labour force participation rate since 2007 is structural in nature.
As a result, while we see some of the current low level of the participation rate as indicative of labour market slack, we do not expect the participation rate to show a substantial increase from current levels as labour market conditions continue to improve.”

The Fed has raised interest rates four times since December 2015 to a range of 1.00% to 1.25%, a still very low level historically but one that may be arguably too high for unusually anemic economic conditions. In particular, some Fed officials have voiced concern over inflation slipping away from the central bank’s elusive 2% target, which it has undershot for most of the recovery. This suggests the economy and the labour market still have plenty of room for improvement.

“The evidence is that there are more people out there willing to present themselves to work and finding jobs than you might have expected,” said Neal Soss, vice chairman for fixed income at Credit Suisse Securities, in an interview with Bloomberg TV. “That’s good and should be encouraged, and I think the Federal Reserve has every intention of encouraging it.”

If you hire, they will come

A new UBS report identifies a number of factors preventing a further decline in labour force participation by looking more closely at rates for specific groups.

Among them, the bank’s economists point to a renewed increase in women’s workforce participation, which climbed steadily for the half-century following World War II from around 34% to 60% but started to decline around 2000. “Since then, it has been on an ever slight upward trajectory. Moreover, the climb for prime-age women has been particularly pronounced,” they write in a research note.

At the same time, UBS finds, the participation rates among those over 25 with high school degrees or less have not only stopped falling “but have actually moved up somewhat, likely bringing male prime-age participation along with it.” The same is true of teenage workers.

This is yet another sign that lower joblessness is attracting new entrants. “Many of these rates may have further room to run,” UBS concludes.

Komal Sri-Kumar, president of Sri-Kumar global strategies, points to the steady erosion in the participation rate for workers aged 25-to-54 as making the case against a demographically-driven drop in the workforce. Some “81.5% of those in this demographic category were in the work force last month compared with 83.2% in December 2007,” he wrote in an opinion piece. “Since the age group comprises the prime working years, there is no easy way to explain this away by pointing to an ageing population or to baby boomers’ desire to retire.”

A new report from the Roosevelt Institute finds, in contrast with the 2014 Fed paper cited above,

at most 40% of the decline in labour force participation reflects demographic changes, while 60% must be due to other factors.”

These are factors that monetary policy can play a role in addressing. Fed policymakers would be remiss to overlook trends in minority labour force participation in their economic assessment.

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