ARGON LERT FullJ EmploymentA

BY TIM SABLIK

ince the 2007-2009 recession ended, unemployment In the 1950s, many economists argued that fiscal and has slowly declined, but most would agree that today’s monetary policy could steer the economy toward the full Slevel of 7.6 percent unemployment does not repre- employment level. By the end of the decade, policymakers sent the economy’s full potential. Full employment is often came to believe they could permanently increase full described as the level of employment at which virtually employment in exchange for some inflation. This idea was anyone who wants to work can find employment at the embodied in the Phillips Curve, which depicted a trade-off prevailing wage. One might assume that if everyone who between unemployment and inflation. Indeed, in the 1962 wants a job has one, then the unemployment level would Economic Report of the President, the Kennedy administration be zero. Yet in the last half century, the unemployment opined, “If we move firmly to reduce the impact rate in the United States has ranged from 2.5 percent to of structural unemployment, we will be able to move the 10.8 percent; it has never been zero. Does that mean we unemployment target…to successively lower rates.” While have never had full employment? policymakers succeeded initially, inflation and unemploy- Not according to economists. Full employment is not ment both rose in the mid-1970s. the same as zero unemployment because there are different Around this time, Milton Friedman and Edmund Phelps types of unemployment, and some are unavoidable or even modified the ideas behind the Phillips Curve by includ- necessary for a functioning labor market. At any given time, ing a natural rate of unemployment for the economy. Policy jobs are being created and destroyed as actions to reduce unemployment below industries evolve, and the transition from that level could succeed in the short run, old jobs to new is not seamless. For example, but in the long run, unemployment would frictional unemployment occurs because return to the natural rate and inflation workers who lose their jobs or quit typically would be higher as a result of expansion- do not accept the first new job for which ary policy. This idea was largely a return to they qualify. Unless they are facing extreme the pre-Phillips Curve understanding of pressure to replace lost income, most full employment as a generally fixed level. people take the time to find a job that fits Although the natural full employment their skills well. Because of this lag, some level is relatively stable, it can change over percentage of the workforce is between time. Changes in the composition of the jobs at any given time and classified as labor market or structural changes in unemployed. industries can shift the full employment Persistent unemployment also arises level. Some economists have argued that from mismatch between the supply of workers changes during the 2007-2009 recession may and the demand for labor at a given wage, which is known as have increased the natural rate of unemployment. They structural unemployment. In a fully flexible market, wages point to the fact that job vacancies have increased without would adjust to the point where the number of people seek- the expected decline in unemployment, suggesting a poten- ing work equaled the number of positions employers were tial mismatch between industry demands and worker skills. willing to provide at that wage. Wages can be set above this The shifting nature of the natural rate of unemploy- level for a variety of reasons, however, such as minimum ment makes it difficult to estimate. Since the 1970s, the Fed wage requirements or because employers choose to set has steered clear of targeting a specific level of unemploy- higher wages in order to get better productivity from their ment, choosing instead to target low and stable inflation. workers. As a result, the supply of labor can exceed the In its December 2012 action, the Federal Open Market demand for it, and structural unemployment arises. Committee (FOMC) indicated that it planned to maintain Since some degree of frictional and structural unemploy- accommodative monetary policy at least until unemploy- ment exists at any given time, economists define full ment fell below 6.5 percent, but Chairman Ben Bernanke employment as the unemployment level resulting from a explained that this rate was not the Fed’s estimate of the combination of these two components, which is always natural rate of unemployment. Additionally, the FOMC greater than zero. Unemployment can rise above this level conditioned its accommodative policy on inflation remain-

due to shocks in the economy, such as the housing market ing near 2 percent. Reflecting the lessons of the 1970s, OOK

collapse that occurred in 2007-2008. It can also temporarily Bernanke noted that attempting to target a precise level of THY C fall below this level if the economy is operating above its full employment risked missing the mark and could “com- TION: TIMO

efficient capacity, resulting in rising prices and wages. promise the FOMC’s longer-term inflation objective.” EF TRA ILLUS

10 E CON F OCUS | SECOND Q UARTER | 2013