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The Fed and Job Growth

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Nothing excites the blood like the fed and monetary policy. So here’s a great piece by Dean Baker getting after the fed for raising interest rates and causing unemployment.

However, there is little basis for concern about sudden spikes in the inflation rate. We haven’t seen large jumps in inflation except in response to events like surging oil prices, which would not be much affected by Fed policy in any case. Most models show that inflation responds slowly to an overly tight labor market. This means that if the Fed were sleeping on the job and allowed the labor market to get tight enough to starting pushing up the inflation rate, we would be looking at price increases on the order of tenths of a percentage point a year, not a sudden surge to double digit territory.

On the other hand, there are enormous potential benefits from allowing the unemployment rate to continue to fall and for more people to get jobs. As a rule of thumb, the unemployment rate for African American workers is twice the unemployment rate for white workers, with the unemployment rate for African American teens roughly six times the unemployment rate for white workers. The unemployment rate for Hispanic workers tends to be roughly 1.5 times the unemployment rate for white workers, although this relationship is more variable. This means that people who most benefit from reduced unemployment are the most disadvantaged groups in society.

This shows up in patterns of wage growth as well. Workers at the middle and bottom of the wage distribution benefit most from a tight labor market. The only time in the last forty years when these workers saw sustained gains in real wages was the low unemployment years of the late 1990s. While this was a prosperous period for workers in general, workers at the bottom of the wage distribution saw the biggest wage gains.

Given the enormous benefits of lower unemployment, it might seem that it would be worth the risk of slightly higher inflation to press the labor market as far as we can. There are few if any social programs that would provide as much benefit to lower income populations as an increase in African American employment by two percentage points and an increase in the employment rate of African American teens of six percentage points, especially if the pay for these jobs rose by 12 percent, which happened between 1995 and 2000.

Someday, economists will realize that the 1970s are not necessarily that relevant for today and adjust accordingly. Someday.

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