Can monetary policy address U.S. long-term unemployment?

Can monetary policy address U.S. long-term unemployment?

With Janet Yellen newly confirmed as Chairman of the Federal Reserve, investors are now parsing her testimony to gain insight on the future direction of interest rates.  

One particularly interesting piece of her testimony involved the persistence of long-term unemployment and a high number of part-time workers: “These observations underscore the importance of considering more than the unemployment rate when evaluating the condition of the U.S. labor market.”

This statement is significant because previous Fed Chairman Ben Bernanke identified a threshold of 6.5% unemployment rate as a starting point for reversing bond purchases aimed at stimulating employment. Currently, the U.S. unemployment rate is very close at 6.6%, but it now looks as if the Fed is hedging its bets.

By continuing to purchase long-term bonds even if it is at a slower pace, the Fed will drive down the interest rate of the 30-year Treasury bonds. Since mortgage rates and other credit rates trend closely to the U.S. Treasury benchmark, they will also remain low. The hope is that this will boost home sales and investment spending, which are drivers of economic growth.

Yellen suggested that labor markets remain slack. As referenced by Jon Hilsenrath of Wall Street Journal’s Real Time Economics, “In her testimony to Congress Tuesday, Federal Reserve Chairwoman Janet Yellen said high levels of long-term U.S. unemployment signaled high levels of slack in the economy which will keep inflation low.”

Therefore, signs indicating that the Federal Reserve will end easy money policies might be premature. Stock markets rose immediately after Yellen’s testimony because investors believe interest rates will remain low. By saying that U.S. long-term unemployment remains high, while inflation is low, we can infer that Yellen will maintain an easy money strategy, as opposed to a tight money strategy. This means that access to credit for consumers and businesses will continue to be relatively cheap. Thus, interest rates should not rise much based on the announcement.

The downside of this strategy is that it will likely continue to create turmoil in emerging countries. This is because Yellen’s strategy will lower the value of the dollar, thus enabling U.S. goods to be cheaper than foreign goods.

The development is troubling, as it could lead countries to respond in two ways, both of which are potentially damaging. The first option is to simply do nothing, which would drive up currencies and make it harder to sell exports. This could result in over-investment within their borders and cause asset bubbles to occur. Another option would be to push currency values down to compete with U.S. exports. However, this strategy is problematic as it could lead to inflation when investors and consumers start to lose confidence in the currency.

It remains questionable whether the Federal Reserve can address long-term unemployment through monetary policy and we must not minimize the potential negative effects. Even if the desired effects of easy money lead to greater investment and job creation, there is certainly no guarantee that employers will rush to hire workers who have been idle with skills that are bound to be rusty.

These employers can rely on existing workers, whose pay has been stagnant. Or they can focus on newly minted college graduates, who would be eager to display their updated skills in the workforce.

A more viable solution must come from U.S. fiscal policy, though the current political rancor makes that a challenging proposition. Even though lower taxes and lessening regulatory burden may provide more job creation and investment, they would also contribute to more income inequality as less marketable workers are passed over for more technology investment or increased bidding for highly skilled workers from an expanding global pool.  Therefore, it is questionable whether this would positively impact long-term unemployment or reverse labor force participation rate trends.

Through a combination of targeted government spending and tax credits, incentives can be realigned to boost the prospects of low-to-medium skilled workers. Certainly, the presence of large deficits complicate this process, but rethinking our workforce development policies might yield some relief to the chronically unemployed without severely compromising our bleak debt position.

Categories: Economics, North America

About Author

Aaron Johnson

Aaron serves as an Assistant Professor of Economics at Darton State College. He holds a M.A. in Economics from the University of Missouri-St. Louis and is a regular contributor on economic analysis for local Fox and NBC news affiliates in Albany, GA.