U.S. inflation hinges on long-term unemployed: Fed study

SAN FRANCISCO, June 30 Mon Jun 30, 2014 1:00pm EDT

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SAN FRANCISCO, June 30 (Reuters) - Whether U.S. inflation next year rises above or remains stuck below the Federal Reserve's 2-percent target will depend in large part on how easily the long-term unemployed find work, a study published on Monday by the San Francisco Fed suggests.

As long as a strengthening economy means better job prospects for all workers, even those who have been unsuccessfully looking for six months or more, inflation looks set to stay well below 2 percent all next year, the study shows.

But if those out of work for long periods stand little chance of actually regaining jobs, demand for workers could rise more quickly than the supply, and inflation could rise above 2 percent before the end of 2015, according to the study. Some economists believe that workers unemployed for long periods may have trouble landing jobs because their skills are eroding or are otherwise scarred.

That is a scenario that some prominent economists, including Alan Krueger, have increasingly embraced. But it has little currency with most Fed policymakers, including Fed Chair Janet Yellen in particular. Yellen believes that even the long-term unemployed will be able to find jobs as employers step up hiring, allowing companies to fill vacancies without putting too much upward pressure on wages.

Forecasts published by the Fed show that most policymakers expect to keep interest rates near zero until well into 2015, allowing the unemployment rate to continue to fall even as inflation stays muted.

The recent study uses a well-known economic model called the Phillips curve to predict inflation under varying scenarios. Most scenarios showed inflation lingering well below 2 percent for all of 2015. But when the researchers excluded the long-term unemployed from their model, they found that inflation could breach 2 percent by mid-2015.

"The reason for the higher inflation projection is that, in terms of the short-term unemployment rate, there is currently little economic slack," wrote Adam Shapiro and Yifan Cao, both researchers at the San Francisco Fed.

(Reporting by Ann Saphir; Editing by Dan Grebler)

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