Wages and Labor Market Slack: Making the Dual Mandate Operational

 

By: David G. Blanchflower (Peterson Institute for International Economics) ; Adam S. Posen (Peterson Institute for International Economics)
In this paper we examine the impact of rises in inactivity on wages in the US economy and find evidence of a statistically significant negative effect. These nonparticipants exert additional downward pressure on wages over and above the impact of the unemployment rate itself. This pattern holds across recent decades in the US data, and the relationship strengthens in recent years when variation in participation increases. We also examine the impact of long-term unemployment on wages and find it has no different effect from that of short-term unemployment. Our analysis provides strong empirical support, we argue, for the assessment that continuing labor market slack is a key reason for the persistent shortfall in inflation relative to the Federal Open Market Committee’s (FOMC) 2 percent inflation goal. Further, we suggest our results point towards using wage inflation as an additional intermediate target for monetary policy by the FOMC.
Keywords: unemployment, wages, inactivity, monetary policy, spare capacity, labor market
JEL: J01 J11 J21 J23 J38 J64
URL: http://d.repec.org/n?u=RePEc:iie:wpaper:wp14-6&r=ltv
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