Yellen Aims for Full Employment

Jacob Hess
February 08, 2021

Newly promoted Secretary of Treasury Janet Yellen has been making her rounds marketing the new administration's economic plans. They include a bulkier stimulus package to build on the bill passed last December as well as bigger picture reforms like a $15 minimum wage. She made headlines this past weekend when she said, "I would expect that if this package is passed that we would get back to full employment next year" when discussing the stimulus package on CNN.

"Full employment" isn't just an abstract concept of the ideal state of employment. No, it refers to a specific level of employment that indicates that the economy is running at full capacity. The Bureau of Labor Statistics (BLS) has a specific definition for the term. It defines full employment as "an economy in which the unemployment rate equals the nonaccelerating inflation rate of unemployment (NAIRU), no cyclical unemployment exists, and GDP is at its potential." The BLS determines whether or not full employment is achieved based on what it calculates "potential GDP" to be and where actual GDP is in relation to it. An economy at full capacity is said to be using all its resources including its labor.

Using this definition, Yellen is claiming that if the $1.9 trillion stimulus package is passed, the economy will reach its full potential by 2022 which will increase capacity such that there is no gap in output. This indeed sounds like a bold claim. In 12 months, the public health situation will be a lot different with vaccines (hopefully) widely distributed and the vulnerable populations (hopefully) mostly protected. Regardless, the economy will have to recover from historic losses in employment including a -20 million monthly job loss in April and the highest unemployment rate of all time at 14.8% (which was arguably higher given a drop in labor participation rate).

Ratio of permanent job losers to total unemployed. Data from FRED.

This drop in unemployment has been more nuanced than in other recessions. It began optimistically as a furlough where workers were told that they had to stay home to obey public health recommendations. Therefore, the level of temporary layoffs rose more than permanent job losses. The ratio of permanently unemployed to total unemployed dropped from 22.7% in February 2020 to 8.7% in April 2020. The last two recessions since 1995 (in 2001 and 2007-2009) did not show this initial trend. However, the latest job report on January 2021 employment data showed that the ratio had surged higher to 34.6% which reflects the previous two recessions.

The leftover permanently unemployed after the temporary layoffs ease will emerge as the cyclical unemployment caused by the demand shock from the pandemic and resulting business losses. At the moment, the 3.5 million permanent job losers data point in the latest report looks to be that magic number. These job losses have been historically harder to resolve (the anemic recovery after the Great Recession is recent evidence). After the 2001 recession, permanent job losers fell at an average of -48,000 a month for the next 25 months. The Great Recession (which had more than twice the amount of permanent job losers than 2001) saw an average drop of -72,000. If the current economy were to follow the faster trend, permanent job losers would only fall -1.7 million in the next two years leaving a total of over 1.8 million at the end of 2022. At the slower pace, a drop of -1.2 million over the next year would leave us just under 2.4 million. Pre-pandemic levels averaged around 1.3 million.

Actual and projected permanent job losers. Data from FRED.

Yellen's claim still looks bold, but that's just in hindsight. The US economy is currently experiencing the easiest monetary policy it's ever seen. On top of that, a $1.9 trillion stimulus bill looks imminent. The stock market at elevated levels is also communicating an expected increase in corporate earnings. In these conditions, things could be different and a fast recovery could be on deck.