US Bond Market Week In Review: Using Last Year’s Model For This Year’s Problem, Edition

The Fed issued its latest statement on Wednesday. It offered the following assessment of the current economy:

Information received since the Federal Open Market Committee met in September suggests that economic activity has been expanding at a moderate pace. Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further; however, net exports have been soft. The pace of job gains slowed and the unemployment rate held steady. Nonetheless,labor market indicators, on balance, show that underutilization of labor resources has diminished since early this year. Inflation has continued to run below the Committee’s longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation moved slightly lower; survey-based measures of longer-term inflation expectations have remained stable.

…..

Inflation is anticipated to remain near its recent low level in the near term but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of declines in energy and import prices dissipate.    

There are several problems with the above passages. First, they’re placing a great deal of importance on the decline in under-utilization, assuming that, as broader measures such as U-6 decline, wage pressures will increase. In short, they still believe in the Phillip’s Curve. But recently Fed President Brainard and Tarullo argued the Phillips Curve was at best very weak in the current environment. And Nick Bunker at the Center for Equitable Growth offers this chart using inflation and a modified employment/population ratio:

The chart does show a positive correlation. But, the current employment/population ratio is too low to provide a meaningful boost to wages. This leads to a more disturbing question: has the decline in the labor force participation rate taken the employment/population ratio to a low too low to have an impact on wages?