Atlanta Fed Economist Researches a "High-Pressure" Economy

January 17, 2019

illustration of a series of pipes under pressure puffing out clouds of steam

If a hot economy helps even disadvantaged workers get jobs, doesn't it make sense to keep stoking the fire?

That is among many questions Federal Reserve monetary policymakers are debating. It is also the subject of recent research by Federal Reserve Bank of Atlanta economist Julie Hotchkiss. In their research paper, Hotchkiss and Robert Moore of Georgia State University dissected whether a "high-pressure economy," one that pushes the unemployment rate below what is considered a natural or sustainable long-term rate, does enough good to justify trying to extend that high-pressure period.

Indeed, disadvantaged workers, including especially African Americans, on average benefit most from these high-pressure periods, the economists found.

But there's a catch. Every high-pressure episode since 1960 has been followed by a recession. (see the chart).

During downturns, disadvantaged workers on average suffer most. Bottom line: the pain of job loss, reduced hours, and pay cuts appears to outweigh the benefits that carry over from exposure to the preceding hot job market, Hotchkiss and Moore concluded.

"We know there's a positive impact on employment outcomes during a high-pressure period, but does that positive impact last?" Hotchkiss said. "The answer is yes, but the positive impact is not large enough to offset even worse outcomes for disadvantaged workers during downturns."

A key element in current monetary policymaking

That answer is informing the thinking of Atlanta Fed president Raphael Bostic, a member of the Fed's rate-setting Federal Open Market Committee (FOMC).

To be sure, the lasting labor market impacts of high-pressure economies is but one of many policy considerations. For instance, another question is whether loose monetary policy, which could prolong a supercharged labor market, could spark inflation and inflate financial bubbles.

Still, the labor market effect of high-pressure periods is a factor Bostic and his FOMC colleagues closely consider. In recent speeches, Bostic said some observers advocate trying to extend high-pressure periods even though a recession has followed each one over the past half-century. The argument is that leaving short-term interest rates very low prolongs the periods of extremely low unemployment, thus helping those who are often the last to benefit from a strong job market, such as minorities, the less educated, and rural residents.

In a speech in Baton Rouge, Louisiana, Bostic cited the work of Hotchkiss and Moore as evidence that "we ought to guard against letting the economy slip too far into these high-pressure periods that ultimately impose heavy costs on many people across the economy. Facilitating a prolonged period of low—and sustainable—unemployment rates is a far more beneficial approach."

So although low unemployment is desirable, keeping it very low could ultimately harm many people economically.

The heat is on

The nation's economy is in a high-pressure period now. The unemployment rate is at 3.9 percent, below the natural unemployment level estimated by the Congressional Budget Office (CBO). (It should be noted that there is no universally accepted definition of where the natural rate of unemployment is, but it is generally defined as the level that is sustainable and does not lead to higher inflation.)

The CBO defines the natural rate of unemployment as "the unemployment rate that arises from all sources other than fluctuations in demand associated with business cycles." Other sources besides normal business ups and downs include what economists call "frictions"—forces that interfere with the smooth functioning of markets—like the time it takes people to find a job or mismatches between workers' skills and the skills employers want.

Debate over whether to extend high-pressure periods has been part of FOMC conversations for some time, Hotchkiss said. Former Fed chair Janet Yellen spoke about the concept in 2016. The puzzle intrigued Hotchkiss, especially after she and Atlanta Fed research colleagues discussed it during a post-FOMC meeting debriefing session. After finishing other research projects, she turned to this question.

Do employers hire more, or give workers more hours?
Federal Reserve Bank of Atlanta Research Economist and Senior Adviser Julie Hotchkiss
The Atlanta Fed's Julie Hotchkiss

Further analysis allowed Hotchkiss and Moore to interpret their results in the context of employers' responses to extraordinarily tight labor markets. Their results suggest that if unemployment suddenly plummets in their geographic area, then they appear to be more likely to rapidly add workers. On the other hand, longer-lasting high-pressure periods lead companies to extend the working hours of their current employees rather than hire more people. Hotchkiss and Moore plan to extend this line of research by exploring the "job-matching" effects of high-pressure periods. (A future episode of the Economy Matters podcast with Hotchkiss will also delve into her research on a high-pressure economy.) In other words, if a worker gets a job in an unusually strong labor market, is that position a good fit for the worker's skills and experience, therefore increasing the likelihood of staying in the job?

Since this study reflects averages across large numbers of people in specific demographic groups, making individual inferences is challenging, Hotchkiss explained. A key feature of the data is that it stretches across long periods, which allows Hotchkiss and Moore to observe many of the same people across multiple business cycles.

What's more, high-pressure periods do not necessarily affect the entire country at the same time. For example, because North Dakota historically has low unemployment, and thus a low natural unemployment rate, this state has experienced only one such episode since 1960. Even then, the unemployment rate did not fall very far below the "natural rate" over the longer term, and it did so only briefly.

By contrast, Mississippi's jobless rate is consistently higher than the U.S. average. Additionally, its labor market is more volatile. Mississippi has seen six high-pressure economic episodes since 1960, and most of them were more intense than what North Dakota experienced.

photo of Charles Davidson
Charles Davidson

Staff writer for Economy Matters

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