Charles Davidson: Welcome to another Economy Matters podcast. I'm Charles Davidson, staff writer with the Atlanta Fed's digital magazine, Economy Matters, and I'm going to be talking today with Julie Hotchkiss. Julie is a research economist and senior adviser who studies primarily labor markets in the Atlanta Fed's Research Department. Julie, thanks for being with us today.

Julie Hotchkiss: Thanks, Charles—it's a pleasure to be here.

Julie Hotchkiss, a research economist and senior adviser in the research department, during the recording of a podcast.
Photo: David Fine

Davidson: All right. Julie's been with us before, so she's a repeat guest. Today we're going to chat about some of her recent research on what is known as a "high-pressure economy" or a "hot economy"—which I believe we are in right now. Julie, is that correct?

Hotchkiss: That's the general consensus, absolutely—yes.

Davidson: All right, okay. Well, thanks for the time again, Julie, and let's get rolling here. So can we start by explaining just what a "high-pressure economy" is?

Hotchkiss: Well, that's an excellent question, and obviously a good place to start. The answer to your question is related to the Federal Reserve's dual mandate. And as you know, the Federal Reserve is charged with maintaining both stable prices and full employment. This essentially translates into trying to get the unemployment rate as low as possible without triggering inflation.

Now, also perhaps as you may know, the Federal Reserve doesn't have any specific tools to affect the unemployment rate, but they are very mindful of the state of the labor market. Also, it's important to remember that an extremely low unemployment rate could be signaling that demand for resources is exceeding the economy's ability to supply those resources, which puts upward pressure on prices and inflation.

Davidson: When you say "resources"—besides people, human resources—what do you mean?

Hotchkiss: Well, it's all of those things that go into production. So in addition to people, that would be equipment and materials and land, things like that. Now, for the service sector, people really is the primary resource. But demand for all of those resources increases during a particularly strong economy. Now, that's a long way to get around to answering your question, which is that a high-pressure economy is one in which the unemployment rate has fallen below the level that forecasters think would increase inflation. And you can think about it really simply as just a really low unemployment rate.

Davidson: Sure, okay. So every high-pressure episode we've had since I guess about 1960 has been followed—really, immediately, I guess—by a recession, right? So is this the inherent tension between unemployment and inflation that you're talking about?

Hotchkiss: Yes, absolutely. You can think about it like blowing up a balloon, right? How much air can a balloon hold before it pops?

Davidson: Okay, "pop" meaning inflation's starting to take off?

Hotchkiss: Exactly.

Davidson: Okay. So now you and your coauthor were basically trying to answer the question, then, of whether a high-pressure economy does enough good while it's going on to justify the Fed trying to extend that high-pressure period. Is that generally correct?

Hotchkiss: Right, exactly. So everyone pretty much agrees that there are inherent risks to running a high-pressure economy, like the potential of popping the balloon as you blow more air into it. But the problem is deciding whether the benefits exceed those risks. Now I'm not sure how far I can push this analogy, but I'll try—it's sort of like asking whether the increased clarity of the picture printed on the balloon that comes with more air being in the balloon is worth the risk of the balloon popping from having more air in it.

Davidson: Okay. You would also really distort the picture if you get too much air in there, I guess. [laughter]

Hotchkiss: That's true—exactly right. So you might have a signal that it's getting too big.

Davidson: Yes, that's cool imagery—I like that. So this question has been part of conversations among the Federal Open Market Committee members for some years now, I believe. Do you feel like they've come down definitively on one side? Do we keep the high-pressure economy going, or don't we?

Hotchkiss: Well, of course, you're talking about a bunch of economists, so what do you think the answer is?

Davidson: One hand, other hand?

Hotchkiss: Right, exactly. [laughter] But seriously, as with all important economic questions, there are so many unknown factors making it virtually impossible to form a definitive answer. First of all, we don't exactly know what unemployment rate is achievable without triggering inflation. We also don't really know whether the unemployment rate is the right indicator of total demand for resources. We also don't know whether the fact that every high-pressure episode since 1960, as you mentioned, has been followed by a recession is a causal observation or if there are other factors underlying both of those things—both the phenomena—that we just can't see.

Davidson: So when you say "causal," Julie, we're looking at whether the high-pressure economy actually caused the recession that came after?

Hotchkiss: Right, whether or not one led to the other, or whether they just both happened to both happen, one after the other.

Davidson: Okay. Is that why your coauthor and you decided to take on this research question, really, was to better identify the unknowns?

Hotchkiss: Well, our specific interest came from speculation by some that in addition to improving contemporaneous labor market outcomes, like unemployment and wages, that certain disadvantaged workers might achieve more long-term benefits from exposure to a high-pressure economy. Specifically, we wanted to see whether exposure to a hot economic environment would improve the relative labor market outcomes during the next recession.

Davidson: So does it?

Hotchkiss: Well, we found, for example, that the same amount of exposure to a hot economy improves the unemployment experience of African Americans during the next recession by more than it improves the unemployment among whites. Now, this would suggest that exposure to a hot economy would be helping to close the gap in labor market outcomes between those groups. However, blacks are hit so much harder on average by a recession than whites that any benefit that they get from the high-pressure exposure is more than wiped out by their average experience of being in the following recession.

Davidson: So does that mean that African Americans, then, don't benefit from being exposed to a high-pressure economy?

Hotchkiss: No, not at all. They absolutely benefit—whites benefit, the educated, the less educated, the young, the old—but our results suggest that benefits are not going to be effective in closing labor market gaps between the advantaged and disadvantaged workers.

Davidson: Okay, now that sounds pretty significant.

Hotchkiss: Well, of course we think it is. [laughter] If the goal is to improve labor market outcomes while the high-pressure environment is going on, then the high-pressure environment is doing its trick. But if we're hoping that exposure to high-pressure environments is improving labor market gaps over time…not so much.

Davidson: Right, okay. So more recently, we've seen some uptick in labor force participation—that is, people being drawn into the labor force, presumably because there are just more jobs out there and it's easier to get one. Is this another effect of the high-pressure economy?

Hotchkiss: Yes, I think that you could say so. When someone is considering whether to put forth the effort to enter the labor force, to look for a job, they consider several things: they consider the value of their time. So, for example, what else could they be spending their time doing? And that consideration is not necessarily impacted by a hot economy. For example, it would be affected by the number of children that you have. They also consider whether the effort will be worthwhile: What's the probability of getting a job? This is going to be directly affected by the state of the economy—the lower the unemployment rate, the higher the probability of finding a job—all else equal, like we like to say. Also, a hot economy will likely affect the pay that a person will be offered once they find a job. So as employers in a hot economy compete for scarce labor, that wage will be bid up, and the higher wage will increase the value of putting forth the effort to look for a job.

Davidson: So, basically it looks like trying to extend the high-pressure economy is not a great idea.

Hotchkiss: Certainly people benefit from running a hot economy, right? Everybody's labor market outcomes are improved, but the question is, can we tell soon enough, or early enough, to sort of let off the gas so that these benefits don't come at an even greater risk of inflationary pressures or unstable financial markets and the other types of risks that macroeconomists want to predict?

Davidson: Right, okay. And so also, if I'm not mistaken, your research finds that in the recession that seems to come after these high-pressure periods, the damage to the groups that benefit from the high-pressure economy basically outweighs the benefits of the high-pressure period.

Hotchkiss: Right. So if you look over the business cycle as a whole, for the last four business cycles that I've looked at, the total negative impact from the recession overwhelms the total benefit that they've received during the hot period. It's both a result from the fact that the cold period, or the recessionary period, lasts typically longer than any hot periods in a business cycle. But also because the average impact is also much greater during a recession than the average bonus, I guess, that disadvantaged workers get during the hot period.

Davidson: Okay, excellent. So what's next here, Julie? Are you guys going to extend this line of research?

Hotchkiss: Well, one specific question that we haven't had a chance to explore yet is whether or not exposure to a hot economy improves what we call a person's job match. If a person is better matched to the job requirements, then they're going to be happier and more productive in that job. But that's what's so great about being a Fed economist, right? I mean, the next time we're talking, it could be on something completely unrelated to this, even.

Davidson: Yes, all right. Well, that's a really cool thing about economics, I think. It's kind of like studying the oceans. It's just so vast and changing all the time that you never really run out of questions. But Julie, thanks so much for being here—it was a really interesting discussion, I think.

Hotchkiss: You're welcome. I always appreciate the opportunity to talk about my research.

Davidson: All right, and thank you for listening. To explore more of Julie's research, as well as lots of other work on the economy and related information, please visit our website—it's at frbatlanta.org. And please come back next month. We're going to have a podcast on the future of the rapidly changing payments landscape, with Claire Green and Nancy Donahue of the Atlanta Fed's Retail Payments Risk Forum. Thank you so much.