Two more years before labor market normal: Fed paper

WASHINGTON Fri Jul 19, 2013 4:21pm EDT

WASHINGTON (Reuters) - It could take another two years before the labor market returns to normal, according to research by the Federal Reserve Bank of Kansas City released on Friday, underscoring how far the economy must still go to regain full health.

The report uses a broad array of 23 labor market indicators, such as long-term employment and hourly earnings, to create measures of labor market improvement and level of activity in the labor market. "Normal conditions" are the roughly 20-year averages of these measures.

The U.S. central bank is using unemployment as a threshold for when it will raise interest rates, and has been promising no hike until it hits 6.5 percent at the earliest. Last month the unemployment rate held at 7.6 percent.

The report's authors, Craig Hakkio and Jonathan Willis, found that the level of activity has been steadily improving since the end of the recession in late 2009, although it remains well below average.

But the labor market has been growing much faster than average, the economists found, picking up in September 2012, when the Fed announced a third round of asset purchases at a pace of $85 billion a month.

The president of the Kansas City branch of the Federal Reserve, Esther George, is one of the most hawkish officials at the central bank and has dissented at every policy meeting so far this year out of concern that bond buying risks financial instability.

The strength of the labor market recovery has direct implications for the fed's monetary policy. As well as using unemployment as a threshold for rate hikes, it has also said it would keep buying bonds until it sees a substantial improvement in the outlook for the labor market.

Fed Chairman Ben Bernanke reiterated in his semiannual testimony before Congress this week that 6.5 percent is a threshold for raising the target federal funds rate.

He also gave labor force participation and its downward pressure on the unemployment rate as an example of other measures the committee could consider in its policy making.

But he said it was too soon to judge if recent "mixed" signals from U.S. economic data would prompt the central bank to delay its plan to taper bond buying later this year.

The Kansas City Fed report addresses this issue directly and begins by saying, "one challenge in assessing labor market conditions is that each month a variety of data are released that may yield mixed signals on the health of the labor market."

(Reporting by Paige Gance; Editing by Richard Chang)