The Kansas City Fed is hosting its annual Jackson Hole conference this weekend (motto: “interrupting Wall Street vacations since 1978”) . Several times in the last few years we have gotten a good preview of the Fed’s concerns for the year ahead by listening to the Chair’s speech. The last two rounds of Quantitative Easing, for example, were foreshadowed by Chair Bernanke’s talks.

The detailed agenda has not been announced yet (watch this space) but it may again be worth taking a day off the beach as the theme of the conference is “Re-Evaluating Labor Market Dynamics” and Janet Yellen’s speech is titled simply “Labor Markets.”

This is timely as one of the most important economic questions of the day is how much slack is truly remaining in the labor market. My forecast, along with many other Fed watchers, is that Yellen will make a point of emphasizing the slack remaining in the labor market.

While the unemployment rate is approaching more normal levels digging deeper we do find evidence of slack beyond the unemployment rate. The number of involuntary part time workers, which I noted in this post, is very high, perhaps three million above typical levels. In addition, the lake wage gains above the level of inflation indicates that despite record corporate profits, employers are not finding it necessary to compete on price. The labor participation rate is more complicated. A large number of people have dropped out of the labor force since the recession though a mixture of the median American getting older and through the difficulty the long-term unemployed have in getting a new job. These contending forces are examined in an interesting report by the Council of Economic Advisors find that about half of the reduction in the labor force is due to aging and about half due to other factors we might hope to be reversed.

Against these indicators of slack what do we see when we look for tightness? I noted the improvement in the unemployment rate above and referring again to my post from July, the quit rate and the job opening rate are both looking as good as they have since the recession and about as good as they did during the last recovery.

Where does that leave the Fed? We can look at the Fed Dual Mandate Report Card below. The X axis show the unemployment rate (with the Fed’s estimate of long run unemployment in pink) and the Y axis shows five-year-ahead expected inflation (with the Fed’s 2% target plus an error band in blue). The details are explained in my post Janet Yellen’s Report Card.

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My interpretation of this chart is that the Fed is in the happy situation when its two mandated goals (price stability and full employment) are not in conflict so there should not be a reason to raise rates any time soon.

In thinking about what the Fed will do in the future we need to bear in mind that by law they are mandated to try and manage both inflation and employment. My sense is that Yellen and most of the FOMC see today’s balance of risks tilted toward problems of employment and will let inflation expectations drift somewhat above their target. This may be a change in tolerances from what many of us are used to from the Fed policy in the 1990-2007 period, as economist Tim Duy writes: “Yellen can point out that since the disinflation of the early 90’s, the Fed has not faced an inflation problem, but instead has struggled with three recessions. This on the surface suggests that monetary policy has erred in being too tight on average.” I hope Chair Yellen will give us some clarification and some arguments to shape the discussion.