Jeffrey Lacker, President of the Richmond Federal Reserve Bank, is joining the Federal Open Market Committee (FOMC), the body within the Federal Reserve with the final say on monetary policy. The presidents of the 12 regional banks occupy five of the seats on the FOMC on a rotating basis (except that the President of the New York Fed is always on the FOMC), Presidents of the Richmond, Philadelphia, and Boston Banks occupying one of the seats on the FOMC, each president serving every third year. Dr. Lacker is replacing Dr. Charles Plosser, President of the Philadelphia Fed, for the 2012 calendar year.
Among Lacker’s duties as President of Richmond Federal Reserve Bank is writing a message in the bank’s quarterly publication Region Focus, the third quarter edition of which I found in my mailbox yesterday. Knowing that Lacker has just become one of the most important people on the planet, I was curious to find out his thoughts at the start of his year on the FOMC. My reading of Lacker’s message in the second quarter Region Focus was not exactly an uplifting experience (see this post from October), but I try to look for glimmers of hope wherever I can find them. Sadly, Dr. Lacker’s message, entitled “Is Joblessness Now a Skills Problem?” offers nothing hopeful.
Lacker begins by painting a bleak picture of the plight of the long-term unemployed.
Today long-term unemployment – that is, unemployment lasting six months or longer – is at a record high. The share of unemployed Americans whose job searches have lasted this agonizingly long is 43.1 percent, a figure that is unprecedented since the Bureau of Labor Statistics began keeping records in 1948.
His explanation?
A growing number of observers have argued that this state of affairs is caused in significant part by a mismatch between available jobs and available workers, especially a mismatch in skills.
I agree that the long-term component of unemployment has structural origins, including a substantial degree of skills mismatch. I hear a fair number of stories from around our District of hard-to-fill job vacancies in certain specialties. Looking at the world around us, it is reasonable to assume that employers need higher skill levels from their workers today, on average, than they did a generation ago. . . . Economic research indicates that the relationship between unemployment and the job vacancy rate changed during the recession; we’re seeing more unemployment for a given rate of job vacancies – which suggests matching problems.
Lacker acknowledges that the skill-mismatch story has been criticized because the empirical evidence suggests that skill-mismatch accounts for only 0.6 to 1.7 percentage points of current unemployment. In turn, Lacker doubts the relevance of the data on which critics of the skill-mismatch story calculate its contribution to current high rates of unemployment. And even if the critics are right, “a percentage point, or 1.5 percentage points, is significant even within the context of today’s unemployment rate of roughly 9 percent.” Lacker concludes:
In short, I think it is quite plausible that skills mismatch is an important factor holding back improvements in the labor market. The question is how important – and that’s an issue that economists are working to answer as precisely as possible.
OK, so what does this all mean for policy? First, Lacker goes out on a limb and announces that he is actually in favor of – hold on to your hats – job training!
Finally, Lacker gets to the point, monetary policy:
Another, more immediate, implication is the extent to which monetary policy can make a difference in getting more Americans into jobs. To the extent that skills mismatch is identified as a significant portion of the long-term unemployment problem, monetary policy will have difficulty making meaningful inroads into the jobs problem without increasing inflation. Monetary policy, after all, doesn’t train people.
This is hugely depressing. Lacker is telling us that because, on the basis of some stories he has heard from around his district (Maryland, Virginia, West Virginia, North Carolina, South Carolina), and because the ratio of unemployed workers to job vacancies has been increasing, he thinks that our unemployment problem is largely the result of skills mismatches, mismatches impervious to monetary policy.
I won’t even bother asking how all these skills matches suddenly appeared out of nowhere in 2008, so let’s just assume that some percentage of the currently unemployed are unemployed because they don’t have the skills to take the jobs that employers are trying so hard to fill, but can’t. But if there is this huge unsatisfied demand for workers out there (of which Lacker claims to have, if not direct personal knowledge, at least hearsay evidence), wouldn’t one expect to observe employers bidding up wages for those desirable employees with those coveted skills?
I mean Lacker can’t have it both ways. Either there are lot of unfilled vacancies that employers are trying to fill, and wages are being bid up to attract the highly prized workers that can fill them, or there are not that many unfilled vacancies and wages are not being driven up by desperate employers trying to fill those vacancies. If Lacker is right about the magnitude of unsatisfied demand for labor, there should be some evidence for it showing up in the wages actually being paid.
So what do the data show? Well, the Bureau Labor Statistics has published since 2001 an employment cost index of wages and salaries for workers in private industry. The chart below shows the quarterly year-on-year change in the index since 2002. As you can see the year-on-year change has come down steadily since 2002, bottoming out at a rate of increase well below anything observed in the 2002-2008 period. If Lacker is right that job mismatch accounts for a significant fraction of currently observed unemployment, why is the rate of wage inflation nearly a percentage point below the lowest observed rate of wage inflation in the 2002 to 2008 period?
Of course, some people regard the 2002-2008 period as one of wild inflationary excess. So I also looked at a similar, but slightly different, index that goes back further than the employment cost index, the labor cost index which takes into account changes in both wages and productivity. The next chart shows the quarterly year on year change in unit labor costs since 1983 (the beginning of the recovery from the 1981-82 recession). The rate of increase in unit labor costs since 2008 is clearly well below the rates of increase for almost the entire period.
And, at the armchair level of analysis at which Lacker is comfortably operating in making his assessments about the role of skills mismatch in the labor market, it is not at all clear that skill deficiencies are the only, or chief, reason for the increasing number of unemployed per vacancy. It would be at least as plausible to suggest that employers are becoming increasingly choosy in selecting job applicants for the few available vacancies that they are trying to fill. Because they are not trying hard to increase output, employers can afford to wait a little longer to find the perfect employee than they would wait if they were trying to expand output. There are two sides to every matching problem, and Lacker seems interested in just one side.
Finally, it is just astonishing that, at a time when inflation is at its lowest rate in a half century, Lacker could offer as an implied rationale for his opposition to using monetary policy to reduce unemployment: “monetary policy will have difficulty making meaningful inroads into the job problem without increasing inflation,” as if any policy option that would increase inflation above its current historically low rate is not even worthy of consideration.
Uneasy Money 
David
Nice. The only encouraging news is that only one “stooge” will replace 3 who have left (P, K & F)! Maybe his “voice” will have a hard time being heard.
http://thefaintofheart.wordpress.com/2011/12/19/bits-pieces-2/
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“I won’t even bother asking how all these skills matches suddenly appeared out of nowhere in 2008…”
Hmmm…Where exactly have you been?
http://research.stlouisfed.org/fred2/series/MANEMP
http://research.stlouisfed.org/fred2/series/DMANEMP
http://research.stlouisfed.org/fred2/series/NDMANEMP
And don’t forget:
http://research.stlouisfed.org/fred2/series/BOPBM
You, like Mr. Krugman seem to cherry pick your data. The destruction of employment (specifically manufacturing employment) began well before 2008.
And no, the “wildly inflationary” period of 2000-2010 did nothing to alleviate this problem.
Inflation (2000-2010):
http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=CPIAUCSL&transformation=pc1&scale=Left&range=Custom&cosd=2000-01-01&coed=2010-01-01&line_color=%230000ff&link_values=&mark_type=NONE&mw=4&line_style=Solid&lw=1&vintage_date=2012-01-05&revision_date=2012-01-05&mma=0&nd=&ost=&oet=&fml=a&fq=Monthly&fam=avg&fgst=lin
Dollar devaluation did not solve the problem:
Major Currencies:
http://research.stlouisfed.org/fred2/series/TWEXMMTH
Broad:
http://research.stlouisfed.org/fred2/series/TWEXBMTH
And the reason none of these policies worked is very simple:
http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=FYGFD&transformation=pc1&scale=Left&range=Custom&cosd=1940-01-01&coed=2010-09-30&line_color=%230000ff&link_values=&mark_type=NONE&mw=4&line_style=Solid&lw=1&vintage_date=2012-01-05&revision_date=2012-01-05&mma=0&nd=&ost=&oet=&fml=a&fq=Annual%2C%20Fiscal%20Year&fam=avg&fgst=lin
Until you fix the debt problem, you will never fix the trade balance problem.The closest to come to it was George H. W. Bush who raised taxes AND cut spending (specifically military spending).
And no, the federal reserve cannot fix a fiscal problem with monetary policy.
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Well stated. I agree that the most depressing thing about the letter is the utter lack of any data to back up the ideas being mentioned.
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Excellent blogging, really top-knotch.
And yes, we see steady trend lines on unit labor costs going to zero and headed to deflation, and yet we get pompous pettifogging from Lacker that really people are unskilled and that is why they don’t have jobs. They were skilled in 2007 and now are hopeless clods.
Skills? When demand for labor is high, people will get OTJ training or find it worthwhile to go to a trade school.
Actually, if there is a real mismatch, I would think the private sector would find ways to train up workers, while the province of monetary policy should be to keep demand good and strong. What is the point of investing in workers in a weak economy?
Lacker seems to belong to the cackling caravan of theo-monetarists, who are grasping for any reason to back up their religion that monetary policy should be tight at all times, especially in a recession.
See, you start with the faith—money should be tight—and work back from there.
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The whole “skills mismatch” argument is parochial US nonsense. There are always shifts in skills demand in a dynamic economy (which is what Frank Restly’s references are picking up). When you get an economy-wide collapse in demand for employment, something else is going on. Such as a collapse in income expectations.
The reason I say the skills-mismatch argument is parochial US nonsense is such folk need to ask why there was not such a sudden “skills mismatch” occurring down here in Australia: we are a first-world economy, really we are.
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It is my feeling that all this talk of a “skills gap” and “structural unemployment” is just a bunch of P.R. planted in the press by those working for the offshore outsourcing firms.
It is planting the seed for a later push to allow in more individuals on work visas even though the real unemployment rate (the U6 rate) is over 17%.
Google for the bill “HR 3012” if you want to see what’s really going on.
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“as if any policy option that would increase inflation above its current historically low rate is not even worthy of consideration.”
Quite so.
A higher inflation rate would transfer hundreds of billions of dollars in buying power *per year* from creditors to debtors. Since the Fed is run by creditors, it’s not hard to understand how they would consider higher inflation to be “not even worthy of consideration.”
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David,
Changing demand for goods and changing technology on the supply side will tend to make some skills less in demand over time. A demand shock that reduces AD and consequently the demand for labor will likely lead to “marginal” workers with these skills losing there jobs first (and explain why this type of unemployment appeared on a much larger scale since 2008).
Left to market forces this demand shock will fast track the supply-side changes needed to the labor market (in both skills and wage-levels).
Would not increasing the money supply to bring AD back to its previous level in these circumstances not just slow down these required adjustment by artificially recreating a demand for skills that the market is trying to price out ?
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It is best to look at the unemployment rate in the U.S. as a World unemployment rate, example, a going rate for a MBA or PhD, and then compare.
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Marcus, You are right that, on balance, we have a better FOMC than we did last year. Let’s hope it makes a difference. It’s called the audacity of hope.
Frank, In the Washington DC metro area, inside the Beltway most days, outside the rest of the time.
Mitch, I’m not sure that one can single out any particular item as most depressing in Lacker’s message. There are so many to chose from.
Benjamin, Thanks. A compliment from you is always worth a lot, because I know you are just as ready to blast me as praise me. There is something about central bankers that just makes them feel that the inflation rate can never be too low. I don’t understand it, but with a few notorious exceptions, they just can’t seem to adjust their mindset.
Lorenzo, Very well said.
TheOutsourcedOne, There are all kinds of reasons why people might be advancing the skills mismatch theory. It’s not obvious to me that yours is the most plausible. But I think it’s pretty fruitless to try to figure out the reasons why people make certain arguments. I just try to assess whether the argument makes any sense.
Steve, You offer yet another theory. I like it a little more than the previous one, but I have nothing much to say about it.
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Dave,
You need to get out more. 🙂
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“Lacker acknowledges that the skill-mismatch story has been criticized because the empirical evidence suggests that skill-mismatch accounts for only 0.6 to 1.7 percentage points of current unemployment.”
Do you have links for this?
Honestly, I’m not sure that the wage inflation numbers are conclusive. If we are talking about a recent development of skills mismatch, the industry that is shedding job would be the old large and established industry. The one that needs more workers is the new smaller one. Depending upon their relative size, you could have skills mismatch and wage deflation. But that’s just because the aggregate doesn’t capture the relative change.
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David, perhaps you talk about macro, and Laker about micro. It is not the same.
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One thought I just had about this is that from the perspective of classical economics (which I guess Lacker shares) there is literally no possibility of a skills mismatch in the economy. If the skills set within the US shifted to be “wrong” for the jobs we used to do (building cars, say) the US as a country would still not suffer from long-term unemployment. What would happen is that we would shift to some other field, for which we have a comparative advantage relative to other nations.
Now it may be true that wages might be lower in those fields than for building cars. But that wouldn’t explain *unemployment*, only falling wages.
His view is wrong within his own point of view, which makes it especially depressing.
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Frank, Not until I save Western Civilization.
PrometheeFeu, Sorry I should have included the link to his message on the web. I have now included it above, but here it is as well
Click to access presidents_message.pdf
Your point seems well taken, but I;m not sure that it is necessarily the case that only large established industries are trying to shed workers and only new startups trying to hire. I also am not sure that it implies that, if Lacker is right, skill shortages would now show up as rising nominal wages somewhere in the data.
Luis, You are right, but if Lacker is right, I don’t think that wage inflation would have remained so low for so long. But I admit that I am just engaging in armchair empiricism (as Lacker is as well).
Mitch, Lacker might actually think that the solution to the problem would be for wages to fall. But I don’t think he would want to come out and say so explicitly.
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