Anyone expecting cautious Fed chair-in-waiting Janet Yellen to reveal anything unexpected about monetary policy at her Senate confirmation hearing Thursday is liable to come away disappointed. But analysts will be paying close attention to whatever she has to say about U.S. labour conditions. While she shares the same hawkish views on inflation as most central bankers, it's the second, more troublesome part of the Fed's dubious dual mandate – promoting maximum employment – that will drive her early decisions.
Yet there is really nothing the Fed can do to fix what ails the labour market. Its massive pump-priming has driven some financial assets into bubble territory, but it hasn't made a dent in the jobless rate. That's because the most troubling piece of the U.S. employment puzzle – a rapidly falling participation rate – remains beyond the reach of monetary policy, no matter how aggressively it's applied.
As long-time Fed watcher Robert Brusca, chief economist with FAO Economics observes, the Fed has been engaged in a trickle-down effort to drive money into places it doesn't usually go, in the hope the wealth effect will reach Main Street and spark more job creation. "There's nothing about this process that causes unskilled, unemployed persons in Flint, Saginaw or Bay City to go to work."
Other developed economies, including Canada's, are faced with a similar problem, as consolidations, efficiencies and a flood of cheap imports trigger deep job cuts, the longer-term unemployed give up looking for work, baby boomers retire in droves and jobless young people stream back to school.
Stronger than expected U.S. job numbers last month persuaded some economy watchers that the Fed now has the improving data it needs to launch a long overdue reduction of monetary stimulus. But officials know that the October results were even less reliable than usual, because of the impact of the federal shutdown on survey collection.
What is obvious is that the improved job stats are being driven by the incredible shrinking U.S. labour force. Remove the dropouts from the equation and the unemployment rate remains as high as ever. If the participation rate remained constant, Mr. Brusca calculates that the jobless rate would be 11.7 per cent, 4.4 percentage points above the actual October reading.
If the departures continue at their current clip, "there will be no individuals working in the U.S. by 2026," senior Bloomberg credit market specialist Chase van der Rhoer writes, with no sign of tongue in cheek. Noting the correlation between the U.S. unemployment rate and the S&P 500, he reckons the index is overvalued by 150 points. And that's without taking into account the dropouts.
Fed chief Ben Bernanke, Ms. Yellen and other key policy-setters have insisted that persistently high unemployment stems largely from lack of demand and other fairly normal cyclical economic factors coming out of a severe recession. Their prescription has been huge doses of the traditional medicine.
But Mr. Brusca is in the camp that contends the labour market is beset by deeper structural flaws, which were merely exposed and exacerbated by the downturn.
"I just don't think it's something that monetary policy can solve," Mr. Brusca argues. "To try to pull these people back into the employment mix, you would have to create a tremendously inflated economy so that even people in the very depressed areas would be drawn into the economic rebound. You're not going to do it with more quantitative easing."
But that won't keep Ms. Yellen from trying. She has observed that if there is too much slack in the economy and the inflation rate is suitably restrained – which it certainly is – the Fed should be devoting more resources to the problem.
If she tells that to the senators, we can expect a Yellen-led Fed to keep pushing on Mr. Bernanke's string.