Janet Yellen says Americans are leaving the work force because there aren't enough jobs, not because they would rather retire or go to school, making an important distinction that shows the Federal Reserve chair will use her influence to keep aggressive monetary policy in place.
At issue is whether demographics and the Great Recession have combined to shrink the number of available workers in the United States, a condition that would demand a more cautious approach to monetary stimulus.
When she appeared on Capitol Hill for testimony in February, Ms. Yellen was more equivocal on the subject of why the U.S. labour participation rate has dropped to its lowest levels since the late 1970s. But she said explicitly Monday that she thinks the U.S. labour market's biggest problem is a lack of jobs, and that she intends to do all she can to help create some.
"Based on the evidence, my own view is that a significant amount of the decline in the participation rate during the recovery is due to slack, another sign that help from the Fed can still be effective," Ms. Yellen said in a speech in Chicago. Later, she reaffirmed that the "extraordinary commitment" the Fed has made to extraordinary policy "is still needed and will be for some time."
The comments should end any confusion about whether Ms. Yellen had turned "hawkish," Wall Street jargon for an inclination to worry more about inflation than a lack of economic growth.
A couple of weeks ago, Ms. Yellen alarmed some Fed watchers by indicating the central bank could raise its benchmark interest rate within six months of the conclusion of its asset-purchase program, a separate stimulus effort that the Fed intends to wind down by the end of the year. That implied a quicker path to higher borrowing costs than some had anticipated. Stock markets rose Monday, suggesting traders are reassured that the Fed's focus remains the recovery.
"Recent steps by the Fed to reduce the rate of new securities purchases are not a lessening of this commitment, only a judgment that recent progress in the labour market means our aid for the recovery need not grow as quickly," Ms. Yellen said.
Critical to the decision of when the Fed raises its benchmark interest rate will be how much "slack" exists in the labour market. If the pool of willing but underused workers is large, then the central bank can keep stoking the economy without fear of creating excessive inflation. As the pool shrinks, inflation risks accelerate.
The U.S. unemployment rate has been dropping swiftly, falling to 6.7 per cent in February from 7.7 per cent a year earlier. The main reason for the decline is that the percentage of working-age Americans who have jobs or are actively looking for work, at 63 per cent, is the lowest it has been since 1978.
There is a lively debate in the United States, including at the Fed, about why the participation rate is so low. The population is getting older, prompting some economists to argue that the participation rate is naturally in decline because former workers are retiring. There also is some evidence that a significant number of the people who lost their jobs in the recession lack the skills for the jobs on offer, and rising student debt levels suggest some workers are choosing to go back to school rather than seek employment.
If these "structural" reasons explain the shrinking participation rate, then there's less the Fed can do to stoke the economy without igniting inflation, which is the likely outcome if monetary policy ends up creating more jobs than there are willing people to fill them. Economists at Barclays Capital in New York argue that this already is starting to happen, prompting them to predict the Fed will be forced to raise interest rates sooner than many on Wall Street currently expect.
Some members of the Fed's policy committee also hold this view, but they are in the minority. The leader of the majority never has been less sure of her opinion. Taking a page out of a politician's playbook, Ms. Yellen in her speech highlighted three unemployed and underemployed Americans by name to make her case that much work is left to be done.
"The recovery still feels like a recession to many Americans," she said.