A fundamental cornerstone of modern macroeconomics is that the economy has a balanced-growth path that is characterized by stable inflation as well as steady growth of production and employment. In effect, if the economy becomes "overheated" and persistently exceeds its balanced-growth path, then the most notable symptom will be an acceleration of nominal wages and prices and hence inflation overshooting the central bank's target. Conversely, a persistent shortfall in economic activity and employment not only has substantial adverse effects on households' well-being but is also associated with downward pressure on wages and prices and hence with inflation falling persistently short of the central bank's target. Thus, ongoing assessments of the contours of the balanced-growth path-and of signicant deviations from that path-are a crucial element of the design and communication of monetary policy, especially for a central bank with a legal mandate to foster maximum employment and price stability.
In gauging movements in labor market slack over previous business cycles, macroeconomists have generally focused on the gap between the conventional unemployment rate (that is, the incidence of people who are out of work and actively searching for a job) and the "natural rate of unemployment" judged to be consistent with the balanced-growth path. In the wake of a severe recession and a sluggish recovery, however, the conventional unemployment gap can be a relatively poor or even misleading indicator of labor market slack. In particular, assessments of the shortfall of employment from the balanced-growth path should also incorporate the extent of hidden unemployment (that is, people who are not actively searching but who would rejoin the labor force if the job market were stronger) and the incidence of underemployment (that is, people working part-time who want a full-time job).
In this paper, we begin by examining the evolution of U.S. labor market slack over recent years and show that underemployment and hidden unemployment currently account for the bulk of the employment gap. Our benchmark assessment of the current magnitude of the shortfall in U.S. employment-including the incidence of underemployment and hidden unemployment is equivalent to about 3.3 million full-time jobs. Moreover, the uncertainty surrounding that assessment is clearly skewed to the upside, so that the actual shortfall in employment might well be twice as large.