"Slack" is a common enough word, and one with many meanings. But to policymakers at the Federal Reserve, slack is a key indicator of economic conditions. When the economy has a lot of slack, say in the form of idle factories or lots of unemployed workers, inflationary pressures aren't likely to be a problem.
Still, it's not always easy to gauge the exact level of slack, particularly when it comes to the labor market. If the economy has little slack and is approaching full employment, then it's time for the Fed to start thinking about putting on the brakes and tightening policy (as in raising interest rates) before inflation gets out of hand.
But if considerable slack persists and "full employment" remains a distant goal, then the central bank can continue with accommodative monetary policy (as in keeping interest rates low) for a much longer period of time.
No wonder the degree of slack in the economy has been the subject of considerable debate both inside and outside the Fed. One issue is how to treat the long-term unemployed. As noted recently on the New York Fed's Liberty Economics blog, the short-term unemployment rate has fallen to near prerecession levels, but the overall unemployment rate remains elevated due to the high level of joblessness among the long-term unemployed.
Here's the problem the New York Fed economists tackled: If the long-term unemployed are, for all practical purposes, out of the labor force and unlikely to be hired because they have different characteristics from the short-term unemployed, then the overall jobless rate overstates the degree of slack. In this case, the labor market consists of mostly the short-term unemployed, and their low unemployment rate could put upward pressure on wages and prices. Therefore, the Fed should consider tightening policy sooner to avoid inflation problems.
But if the long-term unemployed share much the same characteristics as the short-term unemployed and are, thus, part of the pool of job-hunters that employers consider, then the upward pressure on wages and inflation won't occur until the long-term jobless rate falls to levels similar to short-term unemployment. Therefore, the Fed can afford to be much more patient.
The first thing the New York Fed researchers did was to compare the long-term unemployed to three other groups: "the short-term unemployed, nonparticipants who report that they want a job, and nonparticipants who do not want a job."
The economists found that the gender composition of the short- and long-term unemployed is very similar, the age composition is also similar (though prime-age workers are a bit more common among the long-term unemployed), the racial composition is much the same (with "a slightly larger share of African Americans among the long-term unemployed") and the education levels of the two groups are "nearly identical."
They also looked at the industry composition of the short- and long-term unemployed, and again they found little difference between the two groups. The New York Fed researchers -- Rob Dent, Samuel Kapon, Fatih Karahan, Benjamin W. Pugsley and Ayşegül Sahin -- said "they are remarkably similar," and they came to an important conclusion:
On the basis of these observable characteristics, we find that long-term unemployed workers are not less attached to the labor market than short-term unemployed workers. If anything, the long-term unemployed group has the largest share of prime-age workers, the age group likely to have the strongest labor force attachment. We also see that long-term unemployment is an economy-wide phenomenon, spread across industries and occupations. While there may be unobservable characteristics of long-term unemployed workers that make them less attached to the labor force, when looking at their observable characteristics, it's hard to argue that they should not be considered as part of labor market slack.
More simply put, that means the Fed shouldn't forget about or ignore the long-term unemployed when thinking about monetary policy.