You can’t argue with monthly growth of 271,000 jobs and an unemployment rate of five per cent. Wall Street’s response to the release, on Friday, of the U.S. employment report for October showed as much. The yield on Treasury bonds rose sharply as traders priced in a December rate hike by the Federal Reserve, which would be the first in almost a decade. Indeed, some analysts were speculating about a second quarter-point rise come March or April.
That last bit of prognostication was premature, but it does seem highly likely that Fed chair Janet Yellen and her colleagues will act: as recently as Wednesday, Yellen described a December rate hike as “a live possibility.” For the past few months, the Fed has been indicating that it wants to see continued “improvement” in the labor market before pulling the trigger on a rate hike. Since the monthly job figures jump around a lot, one set of numbers should be treated with caution. In the past few months, however, the economy has created almost two hundred thousand jobs a month, and the unemployment rate has come down from 5.3 per cent to five per cent. There were even some signs in the October report that wages, which have been lagging for years, are finally picking up a bit. Taken together, these developments certainly count as an improvement.
But why should the Fed react to good news by raising rates? Does it have to be a spoilsport?
At five per cent, the unemployment rate is now at about the minimum level that the Fed believes is consistent with stable prices over the long term. If the economy keeps expanding in the months ahead, as seems likely, the unemployment rate will probably dip below five per cent, shifting the economy into the zone where textbooks say inflation could start to rise. Although that isn’t a threat now, Yellen and her colleagues are looking ahead.
In an earlier post, I argued that concerns about inflation are overblown. In the twelve months leading up to September, the consumer price index for all items didn’t increase at all. If you exclude food, energy, and other items with volatile prices, the annual inflation rate was 1.9 per cent, which is below the Fed’s target rate of two per cent. With inflation quiescent, an argument can still be made for the Fed to hold fire. Despite a strong jobs report—the strongest of the year—the underlying state of the labor market isn’t as strong as the headline figures suggest.
If you include people who are working part time for economic reasons and people who want a job but haven’t actively looked for one in the past four weeks, the unemployment rate now stands at 9.8 per cent, which is 1.4 percentage points above where it stood in December, 2007, at the start of the Great Recession. That suggests there is still some slack left in the labor market.
In addition, a big reason that the unemployment rate has come down so far in recent years is that many Americans dropped out of the workforce during and after the recession—“the missing millions”—and there is still no sign that they are returning. In the eight years from December, 1999, to December, 2007, when the Great Recession began, the total number of people in the workforce—that is, non-institutionalized adults aged sixteen to sixty-four who are working or looking for work—went from 140.2 million to 153.9 million, a jump of close to fourteen million that largely reflected population growth. Since December, 2007, the population has continued to rise steadily, but the number of people in the workforce has climbed by just 3.1 million, from 153.9 million to 157 million. Relative to the previous eight years, that’s a drop off of more than ten million.
Another way to see what’s happening is to look at the labor-force participation rate, which is the proportion of the working-age population that is working or looking for work. Since December, 2007, it has fallen from 66 per cent to 62.4 per cent, its lowest rate since the late nineteen-seventies. Remarkably, the participation rate has even fallen this year, when the unemployment rate has dropped to five per cent. In October, 2014, it stood at 62.8 per cent.
Now, there are a number of ways you can parse these figures to make them seem less alarming. You can point to the aging of the population and to rising rates of college enrollment among millennials, both of which lower the participation rate. But even when you do this, there remains a big unexplained component, which most likely consists of workers who lost their jobs during the Great Recession, retired early, or went on disability. In a healthy recovery, you would expect a good number of these folks to have returned to the labor force. That hasn’t happened. Arguably, raising rates with the participation rate so low is tantamount to accepting that they never will.
Yellen is well aware of these points, of course. Until recently, she was making similar ones herself. Recently, however, she has been indicating that the Fed can’t afford to wait longer—that with steady job growth, and the unemployment rate at or close to five per cent, it is time to follow the advice of the textbooks and start raising the federal funds rate from the zero bound it has been stuck at since December, 2008.
The issue is that many of the textbooks weren’t written for today’s environment, when G.D.P. growth is slow, the participation rate has tanked, inflation is almost invisible, financial markets are inextricably tied together, and the Fed’s decisions impact the rest of the world more or less instantaneously. If the bank does go ahead and raise rates next month, it will be betting that it can embark on a period of tightening policy without throttling economic growth at home or roiling the global markets. Even if this policy succeeds, there are likely to be some bumps along the way.
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