The connection between job creation and wage growth, once something economists felt fairly confident about, has come completely unmoored from its past history in the last several months, and it has monetary policy experts arguing over how the Federal Reserve should react.
At its most fundamental, the relationship between the jobs market and the average wage should have a supply-and-demand correspondence. As more people get hired, the pool of available workers shrinks, and businesses have to pay more for the talent they need. When jobs are scarce, wages can fall, because employers know both that more talent is on the market, and that current employees aren’t in a hurry to quit an existing job.
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In the years following the Great Recession, however, when the unemployment rate reached a high of 10 percent, wages did not, as might have been expected, take a corresponding dive. They didn’t rise appreciably, either, of course, increasing at a rate lower than already-low inflation. But the economy has created millions of jobs since the recovery began, with well over a million of them created in the past four months alone, and wages still remain flat.
With Friday’s report that the economy created nearly a quarter of a million jobs in September and hourly wages actually dropped by a penny, the argument over the Fed’s next steps became even more intense. The Fed has a “dual mandate” to promote full employment and to keep inflation at levels consistent with strong economic growth.
Friday’s announcement included the news the unemployment rate had ticked down to 5.9 percent, approaching the Congressional Budget Office estimate of the Non-Accelerating Inflation Rate of Unemployment, or NAIRU, the theoretically optimal rate of joblessness.
In theory, the Fed would want to tap the monetary policy brakes right about now by raising short-term interest rates from their current near-zero levels in order to prevent the spike in inflation economists would expect from going below NAIRU. But getting this close to NAIRU with no wage increase suggests that either NAIRU is actually lower than 5.7 percent, or that there is still considerable slack in the job market – meaning discouraged workers who can be lured back into the job market by favorable conditions.
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The story is complicated by two factors. First, the Fed has led the markets to believe that unemployment below 6.0 percent would be a trigger to make the central banks start considering interest rate increases. Second, the continuing decline in the labor force participation rate, which is affected not just by the availability of jobs, but also by multiple demographic factors, makes the theory of a slack labor market a harder sell.
Many, though, believe that slack is the clearest explanation for stagnant wages.
“The fact that wages remain stuck despite of 48 successive months of job gains suggests that employers’ bargaining power remains exceptionally strong,” said Brookings Institution Senior Fellow in Economic Studies Gary Burtless.
“Wage growth has remained stubbornly low despite the drop in the unemployment rate, suggesting that perhaps labor market conditions are indeed weaker than suggested by the headline unemployment rate,” agreed Michelle Meyer, an economist for Bank of America Merrill Lynch in a research note.
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Meyer suggested that, looking at the numbers, the Fed should be in no hurry to raise rates earlier than expected. “[W]ith little sign of wage inflation and continued disinflationary pressures globally, the Fed has the virtue of time,” she wrote. “The ‘core’ of the Fed, including Chair [Janet] Yellen and NY Fed President Dudley, has embraced the ‘balanced approach’ to policy – they are willing to have the unemployment fall below NAIRU if needed to generate stronger inflation.”
Others take the very opposite message from the jobs report.
Peter Boockvar, chief market analyst for the Lindsey Group, saw it as a sign that the economy needs to be cooled down right now. “[T]he Fed has a problem on their hands as the 5.9 percent unemployment rate is at their year end 2014 target and their thesis of a lot of slack in the labor market should be thrown out the window as the participation rate ticks down again,” he wrote to clients. “The labor market is getting tighter, wage increases will eventually follow (labor shortages are being reported) and zero interest rates are wholly inappropriate and actually dangerous at this point in the recovery.”
The nice thing about being a central banker in the United States is that you are under no obligation to produce economic analysis – or to answer your critics in real time. How the Fed reacts to the newest jobs number won’t likely be known until the end of the next meeting of the Federal Open Market Committee on October 28 and 29.
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