Global Daily – Disappearing US labour market slack

by: Nick Kounis , Peter de Bruin

  •  The sharp fall in  the US short-term unemployment rate suggests wage growth will accelerate…
  • …which is good news for consumer demand, and it will not trigger inflation for some time
  • In the eurozone, the Commission upgraded its growth projection, while downgrading inflation

 Global Daily Insight 26 February 2014

Disappearing labour market slack…

In today’s Daily, we look at the number of unemployed in the US and try to assess to what extent labour market slack is disappearing. Using data from the Bureau of Labor Statistics (BLS), we divide the pool of unemployed into short-term (<27 weeks) and long-term unemployed (>27 weeks) and, subsequently, derive short and long-term unemployment rates. In the aftermath of the financial crisis, both rates peaked at historical highs, but the short-term rate has declined considerably faster than the long-term unemployment rate and has dropped below its long term average again. Indeed, at 4.2% in January, it is now a full percentage point below its long-term average of 5.2%.

…despite a historically high amount of long-term unemployed…

In contrast, the long-term unemployment rate, despite falling from its peak of 4.4% in April 2010 to 2.3% in January, has remained comfortably above its long-term average of 1.2%. This means that 2.3% of the labour force, or 3.6 million persons are currently unemployed for longer than half a year. This is a new post-recession low, though still unprecedented from a historical perspective. Intuitively, the longer people are unemployed the smaller the chance of finding a job. This is because if people do not work for a long time, their job skills tend to become out-dated, their social network fades, while they increasingly risk becoming stigmatised. Indeed, according to detailed labour force flow data from the BLS, of those who are unemployed for longer than half a year, roughly twice as many ultimately decide to leave the labour force than end up finding a new job.

…should continue to push up wage growth

All this suggests that one should be careful in thinking that the large pool of long-term unemployed represents labour market slack. Indeed, historically, falls in the short-term unemployment rate have been a much more significant driver of wage growth than movements in the long-term unemployment rate. Indeed, we have already seen a gradual rise in wage growth, and we think that the process will likely continue going forward. This development has a couple of important implications. First of all, this is good news for consumer spending. Second of all, it suggests that there is less slack in the labour market than the Fed currently judges and that short-term interest rates could rise a little earlier than it is signalling. Having said that, rate hikes still look some way off (around the middle of 2015 in our view). Wage growth is rising from low levels and is still below productivity growth rates, which means that unit labour costs are actually falling. There is still a lot of room for accelerating wage growth before it becomes an issue in terms of inflation.

Daily 26 Feb

EC sees firmer economic recovery and lower inflation

Turning to the eurozone, the European Commission published its Winter Forecast update yesterday. It slightly increased its forecast for GDP growth, which is now seen at 1.2% this year and 1.8% next year, which is 0.1 percentage point higher in each year than in the Autumn Forecast. These projections are now broadly in line with our own estimates (of 1.3% and 1.8%, respectively). Olli Rehn, Commission Vice-President for Economic and Monetary Affairs said that ‘the worst of the crisis may now be behind us but…the recovery is still modest’. Meanwhile, the Commission sharply reduced its forecast for inflation to 1% in 2004 and 1.3% in 2015, which compared to 1.5% and 1.4%, respectively, in its previous forecast. In the last quarter of 2015, inflation is still seen at just 1.4%, well below the ECB’s price stability goal. Even the new revised profile for inflation looks to have been overtaken by events. Its forecast for inflation in the current quarter is 1%, while in January it stood at 0.8% and we think that it will most likely go lower still given that slack remains in the economy and commodity prices are subdued.