I must have heard it on the radio recently, because Janet Yellen’s speech at this year’s Jackson Hole conference brought to mind lyrics from one of my favorite Beatles songs:
I’m looking through you, where did you go
I thought I knew you, what did I know
You don’t look different, but you have changed
I’m looking through you, you’re not the same
Yellen’s remarks on last Friday could be described as “surprisingly neutral.” She offered a balanced assessment of labor market conditions that suggests her views are closer to the center of the FOMC than we previously had thought, and notably different from the most dovish FOMC members (e.g. Minneapolis Fed President Narayana Kocherlakota) as well as outside observers with similar ideological stripes (e.g. monetary economist Adam Posen). Indeed, her comments were starkly different in tone than her speech on labor markets in March, when she said that the recovery “still feels like a recession to many Americans, and it also looks that way in some economic statistics,” and “In some ways, the job market is tougher now than in any recession.” Janet Yellen at Jackson Hole was not the dove we thought we knew.
Her remarks of course included the usual statement that there remains slack in the labor market and that the unemployment rate probably understates the degree of slack. However, those conclusions have never really been a matter of debate among mainstream economists. Instead, the key questions are (1) to what degree does the unemployment rate understate slack? and (2) what does that mean for the FOMC’s exit timing? On these questions we saw three important elements in Yellen’s remarks:
First, her description of current trends in the labor market and cumulative progress toward recovery was clearly upbeat. In the opening paragraph she noted the faster pace of payroll growth this year compared to previous years, the fact that payrolls now exceed their pre-crisis peak, and that the unemployment rate has declined almost four percentage points. If she wanted to stress why policy remains easy, we think Yellen would have opened the speech with a different set of statistics. Instead, this sounds like a central banker justifying why policy might need to become less easy.
Second, her extensive discussion of slack was more balanced around the structural factors affecting labor markets than her past remarks, in our view. We would point to: (A) the comment that labor force dropouts related to disability and school enrollment are “clearly and importantly” affected by structural trends; (B) her view that “some portion” of the rise in involuntary part-time work could be structural; © her conclusion that factor models which summarize a wide range of labor market indicators can be a useful guide (these types of indicators show a considerable improvement in slack); and (D) the lack of a central discussion of what is often called the “high pressure economy” view—i.e. that the Fed should overstimulate in order to raise the structural level of employment (the concept was mentioned in footnote number seven in her remarks).
Third, Yellen characterized the idea that policymakers should simply focus on inflation due to uncertainty about slack as “not nearly so straightforward.” She emphasized that other factors besides labor market slack affect inflation, and that there are leads and lags that need to be taken into account. She has made statements along these lines before (e.g. at the press conference following the March FOMC meeting), but it’s nonetheless important to hear the point made again in this type of speech. Our read would be that higher inflation is not an absolute prerequisite for rate hikes—better real economy indicators (i.e. lower slack and solid growth) and higher forecasted inflation might be enough.
Thus, Yellen’s Jackson Hole speech provided some new information about the key labor market questions we have been focusing on. To what degree does the unemployment rate understate slack in the labor market? Yellen’s views seem closer to the CBO and White House—which see a quantitatively modest amount of additional slack—than the larger estimates from economist Andrew Levin (previously a close advisor to Yellen). What does underemployment mean for exit timing? Not a tremendous amount: the FOMC has not switched to a wage-based policy rule and does not seem intent on deliberately overshooting. All of this simply confirms that Fed officials are likely eyeing an exit from zero interest rates—likely by June 2015 or a bit sooner.
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