Rethinking How We Measure Maximum Employment in Today’s Economy

In a recent address, a Federal Reserve official highlighted the evolving complexities of determining "maximum employment"—a cornerstone of U.S. monetary policy—at a time when traditional benchmarks like the unemployment rate are less reliable as standalone indicators. While the Federal Reserve has a clear numerical target for inflation, defining maximum employment is far more nuanced, given its dynamic nature and the multitude of factors that influence it.

The speech traced historical missteps, especially in the 1960s and 1970s, when policymakers relied too heavily on a fixed unemployment rate as a proxy for maximum employment. This approach failed to account for shifts such as changing demographics from the baby boom generation, leading to outsized estimates of economic slack and policies that contributed to sustained inflation. Over the past two decades, the unpredictability of both the Great Recession and the pandemic recession reinforced the inadequacy of a single metric. For example, after the Great Recession, the long-term unemployment rate was far higher than in previous downturns, while the post-pandemic recovery displayed rapid job rebounds driven by temporary layoffs. Both episodes demonstrated the value of considering labor market nuances beyond the headline unemployment rate.

To estimate maximum employment today, several complementary approaches are used. One method analyzes how demographic trends—like age, educational attainment, and gender participation—shift the structural capacity of the workforce. Another incorporates inflation data to assess the level of employment consistent with stable prices, reflecting the "dual mandate" of the Federal Reserve. A third approach attempts to identify the most efficient labor market equilibrium by combining data on job openings and unemployment, aiming to minimize both idle workers and unfilled positions. Notably, recent estimates from these models converge around an unemployment rate of 4.2 percent.

The conclusion emphasized the importance of a diverse toolkit: no single statistic can capture the full picture of maximum employment, especially as different economic shocks and labor market trends play out. By leveraging multiple indicators—including demographic composition, job duration, and job flows—policy makers are better equipped to steer the economy toward stable growth without unnecessary inflation.

This evolving perspective on measuring maximum employment is crucial for setting effective monetary policy in a dynamic and unpredictable economic environment.