{"id":2035,"date":"2016-05-10T17:03:02","date_gmt":"2016-05-10T17:03:02","guid":{"rendered":"http:\/\/cfe.econ.jhu.edu\/?p=2035"},"modified":"2024-01-24T12:26:21","modified_gmt":"2024-01-24T17:26:21","slug":"six-degrees-of-separation-between-jobs-and-inflation","status":"publish","type":"post","link":"https:\/\/krieger.jhu.edu\/financial-economics\/2016\/05\/10\/six-degrees-of-separation-between-jobs-and-inflation\/","title":{"rendered":"Six Degrees of Separation between Jobs and Inflation"},"content":{"rendered":"\n
Friday\u2019s reported increase of 160,000 in nonfarm payrolls was less than the recent average. This doesn\u2019t mean much for the macroeconomic outlook and, therefore, shouldn\u2019t and probably won\u2019t mean much for the path of monetary policy.<\/p>\n\n\n\n
Monthly nonfarm payroll gains bounce around a good deal and are substantially revised. Moreover, weather-especially winter weather–can dramatically affect the numbers. Remember that seasonal adjustment accounts for the typical effect of winter, not for the particular winter we experience. The CFE\u2019s Jonathan Wright, one of the leading experts on this topic, regularly publishes a weather adjusted payrolls series. By his reckoning, this winter\u2019s weather, including that nasty April in much of the country, may fully explain the weakness in today\u2019s report.<\/p>\n\n\n\n
More importantly from a policy perspective, we think that much discussion of the job-gains-to-policy link at present is deeply misguided. In particular, there is a view that the pace of job growth over the last year or so is dangerously high and must soon begin slowing lest we push the job market to the bursting point. In this view, we need upward adjustments to the path of interest rates until those job gains of over 200,000 a month slow considerably.<\/p>\n\n\n\n
Let\u2019s accept a deep truth: job growth at the recent pace cannot continue indefinitely<\/i>: ultimately an increase in payrolls of over 200,000 per month must take the economy above any reasonable sense of sustainable employment, and this would be destabilizing. Conventional Phillips-curve reasoning goes like this. As slack in the labor market evaporates, wages are sure to accelerate. As real wage gains exceed the gains for labor productivity, corporations see their margins erode, and this prompts them to raise prices, a process that generate a destabilizing inflationary environment. By destabilizing<\/i>, we basically mean that that the Fed may either respond so sharply as to risk recession or so weakly as to allow inflation to jump to unacceptable levels.<\/p>\n\n\n\n
O.K., so if strong job growth persists too long it would ultimately set in motion an inflationary dynamic, and if that begins to build and prompts a Fed response that is too weak or too strong, bad outcomes would follow. But even acknowledging all that logic, still leaves us a country mile from the conclusion that we need slower job growth today<\/i>.<\/p>\n\n\n\n
Let\u2019s consider instead an economy in which the job growth at a rate something over 200,000 per month continues for, say, another 18 to 24 months. The assertion that this would dangerously overheat the economy requires us to believe the Phillips curve mechanism, and also to believe that we have a pretty good grasp of the myriad factors that determine just when job gains translate into dangerous inflation pressures. At last summer\u2019s Jackson Hole Conference, Jon Faust and Eric Leeper reviewed how well the best thinkers and policymakers have historically done in assessing these factors. The record shows essentially no relation between inflation outcomes and inflation forecasts based on real-time assessments of labor market tightness. In Faust and Leeper\u2019s argument, the standard Phillips curve forces operate in the economy, but they are regularly swamped by those myriad other factors–disparate confounding dynamics<\/i>. Faust and Leeper base their argument on the normal period<\/i> before the financial crisis\u2014you remember, back when things were comparatively simple. No one contends things are simple today, and, in our view, there is no reason to believe that the current pace for employment growth if continued for a year or two would risk a destabilizing inflationary environment.<\/p>\n\n\n\n
Let us spin out these disparate confounding dynamics in the form of six degrees of separation between the current pace of job growth and those bad inflation outcomes.<\/p>\n\n\n\n
1. Amid continued strong job gains, the labor force participation rate rises forestalling a tightening of the labor market <\/b><\/p>\n\n\n\n
2. Amid continued rapid job gains, the labor market continues to tighten and the unemployment rate continues to fall, but sufficient slack remains so that little upward pressure on wages and prices emerges over the next couple of years. <\/b><\/p>\n\n\n\n
3. Amid strong job growth, upward pressure on wages causes a rise in wage inflation, but labor productivity accelerates offsetting any inflation pressure <\/b><\/p>\n\n\n\n
4. Amid rapid job growth, real wage growth rises above the rate of productivity growth, but inflation does not pick up as labor\u2019s share of income rebounds from historic lows.<\/b><\/p>\n\n\n\n
5. Amid strong job gains, inflation accelerates, but inflation expectations remain anchored and no destabilizing dynamic emerges.<\/b><\/p>\n\n\n\n
6. Amid strong job gains, inflation accelerates and inflation expectations begin to climb. The Fed responds as the inflation becomes apparent, avoiding any destabilizing effects <\/b><\/p>\n\n\n\n
The analysis that follows simply gives an illustration of these six points.<\/p>\n\n\n\n
Job gains need not imply a tighter labor market if the increase in jobs is met by new workers joining the labor force. Of course, it is widely accepted that the labor force participation rate (LFPR) over the longer run in the U.S. will be falling<\/i> as the large baby boom generation retires. To put some rough numbers on this, take the 2016:Q1 participation rates by age cohort (Table 1, col. 2) and hold them constant for the next 2 years in what we\u2019ll call a the no change<\/i> scenario. Given the BLS\u2019s reported population forecasts by age cohort<\/a>, the demographics of our aging population over these two years would imply that the overall LFPR would fall by about half a percentage point to 62.5 percent.<\/p>\n\n\n\n Table 1. Particiaption rates by age cohort. Source: data, BLS via Fred; scenarios due to authors.<\/p>\n\n\n\n But the participation rates are not constant by cohort. For example, the participation rate in the age 55-64 cohort has been increasing for over 20 years. And the participation rate of the 25-54 group has recently been rebounding from post-recession lows, jumping from 80.6 to 81.4 over the year ended Q1:2016.<\/p>\n\n\n\n Consider the following upbeat<\/i> scenario (Table 1, col. 3). The 25-54 participation rate rises for the next two years at about half the rate it rose over the 2 quarters ending in March. After two years, this still leaves it well below its pre-recession peak. The steady rise in the 55-64 participation rate continues. The participation rates in the youngest and oldest cohorts remain unchanged. Using the same population numbers used above, the overall participation rises to 63.5 percent in the upbeat scenario, as compared to a fall to 62.5 percent in the no change scenario.<\/p>\n\n\n\n The implications of these seemingly modest changes in the participation rate are quite striking when one considers the pace of job growth and the unemployment rate. For example, the median FOMC forecast for unemployment in 2018:Q1 is just below 4.6 percent. Under the no change scenario, job gains of 110,000 per month would roughly deliver this outcome. In the upbeat scenario, it takes job gains of 220,000 per month to reach that same unemployment rate.<\/p>\n\n\n\n Modest adjustments of the participation rate by age cohort over the near-term could allow the current pace of job creation to continue into 2018 while delivering an unemployment rate that the FOMC projects is consistent with inflation rising slowly to 2 percent.<\/p>\n\n\n\n Historically, as the unemployment rate falls to 5 percent, this has signaled a relatively tight labor market and a noticeable acceleration in hourly wage gains. This regularity helps explain why most FOMC members report something like 5 percent for the long-term normal unemployment rate. In the past, however, those 5 percent jobless rates were generally accompanied by similarly low levels for other measures of labor market slack. Today, as the Fed regularly reminds us, many broader measures of unemployment remain much higher than the past relation with headline unemployment would predict.<\/p>\n\n\n\n For illustrative purposes, Fig. 1 shows the conventional (U-3) unemployment rate alongside a broader measure that we\u2019ve constructed. The broader measure includes U-3, the rate of involuntary part time work, and a measure of prime age participation rate shortfall. From 1985 to the crisis, the two measures mirror each other, and, in particular, both measures tended to dip below 5 percent at the same time. Currently the more comprehensive slack measure stands above 6 percent–more than a full percentage point above the conventional unemployment rate.<\/p>\n\n\n\n <\/td> Actual<\/td> 2018:Q1 scenario<\/td><\/tr> Age<\/td> 2016:Q1<\/td> No Change<\/td> Upbeat<\/td><\/tr> <\/td><\/tr> All<\/td> 63.0<\/td> 62.5<\/td> 63.5<\/td><\/tr> 16-24<\/td> 55.4<\/td> 55.4<\/td> 55.4<\/td><\/tr> 25-54<\/td> 81.4<\/td> 81.4<\/td> 83.4<\/td><\/tr> 55-64<\/td> 64.4<\/td> 64.4<\/td> 65.0<\/td><\/tr> 65-74<\/td> 27.3<\/td> 27.3<\/td> 27.3<\/td><\/tr> 75+<\/td> 8.3<\/td> 8.3<\/td> 8.3<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n 2. Amid continued rapid job gains, the labor market continues to tighten and the unemployment rate continues to fall, but sufficient slack remains so that little upward pressure on wages and prices emerges over the next couple of years.<\/h3>\n\n\n\n