Wages and Labor Market Slack: Making the Dual Mandate Operational

29 Pages Posted: 24 Sep 2014 Last revised: 15 Nov 2014

See all articles by David G. Blanchflower

David G. Blanchflower

Dartmouth College - Department of Economics; National Bureau of Economic Research (NBER); University of Stirling - Department of Economics

Adam S. Posen

Peterson Institute for International Economics

Date Written: September 23, 2014

Abstract

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 Classification: J01, J11, J21, J23, J38, J64

Suggested Citation

Blanchflower, David G. and Posen, Adam S., Wages and Labor Market Slack: Making the Dual Mandate Operational (September 23, 2014). Peterson Institute for International Economics Working Paper No. 14-6, Available at SSRN: https://ssrn.com/abstract=2500464 or http://dx.doi.org/10.2139/ssrn.2500464

David G. Blanchflower (Contact Author)

Dartmouth College - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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University of Stirling - Department of Economics ( email )

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Adam S. Posen

Peterson Institute for International Economics ( email )

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202-328-5432 (Fax)

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