In the mid- to late-1990s, when I had been at the Chicago Fed for only a short time, one of the big questions was whether inflation would increase given the tightening labor market. The unemployment rate had fallen from 7-3/4 percent in 1992 to 5-1/2 percent in early 1995. Conventional thinking at the time was that the natural rate of unemployment was around six percent. So when unemployment went below that six percent level, a number of people worried that accelerating inflation was just around the corner...  Most analysts have since revised their estimates of the natural unemployment rate, putting it in the range of five percent.

...Demographic changes also are a factor in the decline in the natural rate of unemployment. As the baby boom generation acquired more working experience, their ability to find jobs improved. It happens to every generation. Experienced workers have more employable skills, know more about what jobs match their skills, and have built a broader network to help them conduct a job search. Since 1960, the unemployment rate for 25-34 year olds has been about two percentage points higher than the unemployment rate for 45-54 year olds, on average. In the late 1980s, about 15 percent of the labor force was 45-54. This share has since trended up and now appears to be peaking at 23 percent. In turn, the natural rate of unemployment for the entire economy should be lower because of the relatively higher employability of these workers, who now constitute a larger portion of the workforce.

Despite the ever shrinking pool of available labor, recent readings on year-over-year increases in labor compensation have held steady or, by some measures, even eased. This seems to have resulted in part from falling inflation, which has implied that relatively modest nominal wage gains have provided healthy increases in purchasing power. Also, a residual fear of job skill obsolescence, which has induced a preference for job security over wage gains, probably is still holding down wage levels.

How is it possible, first, for hourly compensation growth to be flat or falling in an ever-tightening labor market? Let me begin by suggesting what does not explain it. You may recall that two or three years ago I was arguing that fear of job obsolescence was a major factor suppressing the nominal increase in compensation per hour. That factor clearly has not gotten worse; if anything, it has eased. The International Survey Research Company is the source of the data that I was quoting back in 1995 and 1996, as you may remember. When workers were asked whether they frequently were concerned about being laid off, 46 percent responded “yes” in 1995 and 1996 compared with figures in the teens or in the twenties throughout the 1980s. The 46 percent number is now down to 37 percent. Statistics on job leavers, another indicator I would use, likewise do not indicate any significant change. So an increase in uncertainty and the fear of job loss amongst workers cannot account for this extraordinary combination of low unemployment and no acceleration in hourly compensation.

As I pointed out here last February, polls indicated that despite the significant fall in the unemployment rate, the proportion of workers in larger establishments fearful of being laid off rose from 25 percent in 1991 to 46 percent by 1996. It should not have been surprising then that strike activity in the 1990s has been lower than it has been in decades and that new labor union contracts have been longer and have given greater emphasis to job security. Nor should it have been unexpected that the number of workers voluntarily leaving their jobs to seek other employment has not risen in this period of tight labor markets.

To be sure, since last year, surveys have indicated that the proportion of workers fearful of layoff has stabilized and the number of voluntary job leavers has edged up. And, indeed, perhaps as a consequence, wage gains have accelerated some. But increases in the Employment Cost Index still trail behind what previous relationships to tight labor markets would have suggested, and a lingering sense of fear or uncertainty seems still to pervade the job market, though to a somewhat lesser extent.

But the rate of pay increase still was markedly less than historical relationships with labor market conditions would have predicted. Atypical restraint on compensation increases has been evident for a few years now and appears to be mainly the consequence of greater worker insecurity. In 1991, at the bottom of the recession, a survey of workers at large firms by International Survey Research Corporation indicated that 25 percent feared being laid off. In 1996, despite the sharply lower unemployment rate and the tighter labor market, the same survey organization found that 46 percent were fearful of a job layoff.