Low Unemployment: The Recipe for Higher Wages1st February 2019
Back in 2013, Jared Bernstein and I wrote a book called Getting Back to Full Employment: A Better Bargain for Working People (free download). The main point of the book was that low unemployment rates disproportionately benefited those who are most disadvantaged in the labor market. For this reason, we argued for using macroeconomic policy to get the unemployment rate as low as possible, until inflation became a clear problem.
At that time the unemployment rate was still close to 7.0 percent. It was still coming down from its Great Recession peak of 10.0 percent, but there were many economists, including many at the Federal Reserve Board, who argued that it should not be allowed to fall below a range between of 5.0-5.5 percent, because lower rates of unemployment could trigger spiraling inflation.
In fact, this was pretty much the consensus view in the economics profession. At the time, the Congressional Budget Office (CBO) put the non-accelerating inflation rate (NAIRU) of unemployment at 5.5 percent. The NAIRU is essentially the target rate of unemployment for policy makers, since they want to prevent the accelerating inflation that would result if the unemployment went much lower. CBO’s numbers are also important in this respect, not only because it is seen as an authoritative source, but also by design it tries to produce estimates that are well within the consensus in the economics profession.
Our argument was directed at these people. We felt the evidence that unemployment rates this high should pose any sort of floor for macroeconomic policy were weak. We also pointed out that economists had been badly mistaken two decades earlier, in the 1990s, when they argued that the unemployment rate could not get below 6.0 percent without triggering spiraling inflation.
Fortunately, the Greenspan Fed ignored that view and allowed the unemployment to fall to 4.0 percent as a year-round average in 2000. This gave us the late 1990s boom, the only period of sustained real wage for those at the middle and bottom of the wage ladder since the early 1970s. Given the enormous gains from allowing the unemployment rate to fall further, we felt the Fed should take the small risk of accelerating inflation, and allow the unemployment to continue to decline below the conventional estimates of the NAIRU.
Thankfully, Janet Yellen, who was then Fed chair, agreed with this position. (It helped that our friends with the Fed Up Coalition were also pushing hard in this direction.) She held the Fed’s key federal funds rate at zero until December of 2015, at which point the unemployment rate had fallen to 5.0 percent. Since then, the Fed has had a path of moderate rate hikes (faster than I would have liked), that have not prevented the unemployment rate from falling further.
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