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Why Fed Chair Yellen Says Unemployment Is Still Too High

By Kurt Avard – Feb 22, 2014 at 9:09AM

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The Fed chairwoman says interest rates must stay low to combat unemployment.

"The recovery in the labor market is far from complete." - Janet Yellen

Testifying before Congress last Tuesday, new Federal Reserve chairwoman Yellen told representatives that the U.S. economy is not yet ready for increased interest rates. Claiming that the Fed has a responsibility to aim for maximum employment as well as price stability, the chairwoman noted that the Reserve's mandate could not be considered accomplished in light of recent studies.

Saying that the Fed must create "financial conditions [that] support consumer spending, business investment, and housing construction," Yellen's push highlights systemic issues that have plagued the U.S. recovery from the 2009 recession. Although a "dove" by Wall Street standards in that she's more concerned with unemployment than with inflation-based issues, there is evidence to support a focus on U.S. unemployment, which has remained high despite national programs. 

In historical terms...

Compared to the three most recent U.S. recessions (in 2001, 1991, and 1982), 2009 has set a new record of negative standards. This recession has experienced the greatest absolute increase in unemployment (with a nearly 5% rise in the labor metric), and has recovered the slowest out of the four most recent recessions. Finally, while unemployment has dropped from peak recession highs of approximately 10% to current levels of 6.6%, unemployment levels are still almost 2% higher than pre-recession levels, again the worst of the most recent recessions.

Even worse, the decline of unemployment is not indicative of any gains in employment. Rather, the percentage of employed Americans has actually fallen since the beginning of the recession by almost 4%. While a subset of this group is simply baby boomers retiring, historical trends indicate that employment should rise by at least 2% five years after a given recession. The fact that this has not happened means that an increasing number of unemployed are simply giving up on the job market due to rather bleak job prospects. 

The final proverbial nail comes in the historic highs of long-term unemployment. At its highest levels since the so called "Great Recession" of the early 1980s, long-term unemployment hovers near 38% of all unemployed people. That is, nearly two in five have been unemployed for longer than 27 weeks, or about six months. Coupled with the 12.7% of U.S. citizens working part-time positions because long-term work cannot be located, the U.S. economy remains in a very fragile state with about 20 million un- or underemployed. 

What can be done?

Yellen is right to keep interest rates low, some say. Believing that inflation and unemployment rates are inversely related (that is, one increases as the other decreases), Yellen is forced to walk a tight rope. If she keeps interest rates low for too long in an attempt to encourage employment efforts, the U.S. economy could actually contract further. (Allowing an increase in inflation leads to potential increases in output and, thus, increases in revenue for a state. This is derived from an economic model known as the Phillips curve model.)

Unfortunately, there is little more that Yellen can do, restricted to simple monetary policy options in her role at the Fed. Ultimately, the buck passes to Congress and the White House. This is somewhat disconcerting, given the continuing partisan conflicts that plague the legislative branch. The best course of action right may be to extend unemployment benefits to maintain consumer spending and participation in the economy. This has not happened yet, but there is always the possibility of a compromise in the near future.

A bright side?

Unemployment might take care of itself. It is entirely possible that the extended (comparative to previous recessions) nature of the 2009 recession is causing a delay in the natural recovery of the U.S. economy. If this is the case, then Yellen has little to worry about. Of course, this is little consolation to the new Fed chairwoman who has been given the end of a very short stick. 

Hey, at least prices are not sky-rocketing ... yet. 

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