NEW YORK (MNI) – The following is the second of seven sections of
Federal Reserve Vice Chair Janet Yellen’s text and footnotes prepared
Wednesday for the Money Marketeers of New York University:

Finally, I do not interpret data suggesting an outward shift in the
Beveridge curve as providing much evidence in favor of an increase in
structural unemployment. The Beveridge curve plots the relationship
between unemployment and job vacancies. Cyclical variations in aggregate
demand tend to move unemployment and job vacancies in opposite
directions, whereas structural shifts would be expected to move
vacancies and unemployment in the same direction. For instance, a
structural mismatch between businesses hiring needs and the skills of
unemployed workers would tend to push up the level of vacancies for a
given level of unemployment. Figure 3 plots the co-movement of
unemployment and job vacancy rates since 2007.5 Consistent with a
substantial decline in aggregate demand, followed by some modest
recovery, movements in unemployment and vacancies since 2007 display a
predominantly inverse relationship.

However, figure 3 shows that as job vacancies have risen during the
recovery, unemployment has declined by less than might have been
expected based on the relationship that prevailed during the
contraction. This outcome has led some to suggest that the Beveridge
curve has shifted outward, reflecting an increase in the extent of job
mismatch. In my view, a portion of this apparent outward shift in the
Beveridge curve reflects increases in the maximum duration of
unemployment benefits, which have been important in buffering the
effects of the weak labor market on workers and their families. The
influence of these benefits will dissipate as they are phased out and
the economy recovers. In addition, loop-like movements around the
Beveridge curve are common during recoveries. Vacancies typically adjust
more quickly than unemployment to changes in labor demand, causing
counterclockwise movements in vacancy-unemployment space that can look
like shifts in the Beveridge curve.

Figure 4 plots the relationship seen during and after the 1973 and
1982 recessions alongside the current episode. As can be seen, such
counterclockwise movements also occurred during these two earlier deep
recessions.6 While I do not see much evidence of any significant
increase in structural unemployment so far, I am concerned that
structural unemployment could increase over time if the labor market
heals too slowly — a phenomenon known as hysteresis. An exceptionally
large fraction of those now unemployed — more than 40 percent — have
been out of work for six months or more.

My concern is that individuals with such long unemployment spells
could become less employable as their skills deteriorate and as they
lose their connections to the labor market. This outcome does not appear
to have occurred in the wake of previous U.S. recessions, but the
fraction of the unemployed who have been out of work for a long period
is much higher now than it has been in the past. To date, I have not
seen evidence that hysteresis is occurring to any substantial degree.
For example, the probability of finding a new job has not deteriorated
more for individuals experiencing a long-term bout of unemployment
relative to those facing shorter spells. Nonetheless, the risk that
continued high unemployment could eventually lead to more-persistent
structural problems underscores the case for maintaining a highly
accommodative stance of monetary policy.

Figure 2 illustrates the degree of uncertainty surrounding
projections of unemployment. The gray shading denotes a model-based 70
percent confidence interval for the unemployment rate, based on the
sorts of shocks that have hit the economy over the past 40 years.3
Judging from historical experience, the consensus projection could be
quite far off, in either direction. That said, the figure also shows
that labor market slack at present is so large that even a very large
and favorable forecast error would not change the conclusion that slack
will likely remain substantial for quite some time.

Putting all the evidence together, I see no good reason to doubt
that our nations high unemployment rate indicates a substantial degree
of slack in the labor market. Moreover, while I recognize the
significant uncertainty surrounding such forecasts, I anticipate that
growth in real gross domestic product (GDP) will be sufficient to lower
unemployment only gradually from this point forward, in part because
substantial headwinds continue to restrain the recovery.

One headwind comes from the housing sector, which has typically
been a driver of business cycle recoveries. We have seen some
improvement recently, but demand for housing is likely to pick up only
gradually given still-elevated unemployment, uncertainties over the
direction of house prices, and mortgage credit availability that seems
likely to remain very restricted for all but the most creditworthy
buyers. When housing demand does pick up more noticeably, the huge
overhang of both unoccupied dwellings and homes in the foreclosure
pipeline will likely allow demand to be met for a time without a sizable
expansion in homebuilding.

A second headwind comes from fiscal policy. State and local
governments continue to face extremely tight budget situations in light
of the weak economy, depressed home prices, and the phasing out of
federal stimulus grants, though overall tax revenues have been improving
and that should continue as the economy expands further. At the federal
level, stimulus-related policies are scheduled to wind down, while both
real defense and nondefense purchases are expected to decline over the
next several years under the spending caps put in place last year.

A third factor weighing on the outlook is the sluggish pace of
economic growth abroad. Strains in global financial markets have eased
somewhat since late last year, an improvement that reflects in part
policy actions taken by European authorities. Nonetheless, risk premiums
on sovereign debt and other securities are still elevated in many
European countries, while European banks continue to face pressure to
shrink their balance sheets, and concerns about the outlook for the
region remain. A further slowdown in economic activity in Europe and in
other foreign economies would inhibit U.S. export growth. For these
reasons, I anticipate that the U.S. economy will continue to recover
only gradually and that labor market slack will remain substantial for a
number of years to come.

-more- (2 of 7)

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