(This post first appeared on my Patreon page.)
The June jobs report showed the economy created 224,000 jobs in the month, a sharp increase from the revised level of 72,000 reported for May. With considerable evidence that the economy is slowing, and the ADP report showing the economy created just 102,000 jobs in June, the jobs growth number from the Bureau of Labor Statistics was much higher than most analysts had expected.
It led the markets to reverse their expectations of a July cut in the federal funds rate. With average job growth of 171,000 over the last three months, the thinking was that the Fed did not need to provide any additional boost to growth. A bit deeper look suggests that additional stimulus may still be a good idea.
First, it is important to remember where the labor market is. The June unemployment rate of 3.7 percent certainly looks very good relative to almost any other point in the last fifty years.
However, if we look at employment rates (EPOP) for prime age workers (ages 25 to 54), the labor market does not look so great. The June EPOP was 79.7 percent. That is down from a pre-recession peak of 80.3 percent. It is far below the 2000 peak of 81.9 percent. It’s even down from the 79.9 percent peak for the recovery hit in January and February of this year.
The weak EPOP suggests that the economy has room to expand. There have been repeated efforts throughout this recovery to attribute low EPOPs to workers’ reduced interest in working, primarily among young men. This story does not work well for two reasons.
First EPOPs were down pretty much across the board, so a story that young men have lost interest in working could not explain lower EPOPs among older men and women of all ages. The other reason the reduced interest in working story didn’t fit is that EPOPs of young men (ages 25 to 34) have risen considerably as the recovery strengthened, going from just over 82 percent in 2013, when this argument was first being put forward, to a peak of more than 86 percent last year.
Weak demand easily explains the pattern we saw, a lack of interest in working among young men does not. It is worth noting that EPOPs among young men have fallen by 1.2 percentage points from the peak hit in November, so perhaps those claiming a lack of interest in working were just premature. (That’s a joke.) Anyhow, prime age EPOPs certainly indicate there is room for further expansion of the labor market.
Other measures also do not indicate a labor market hitting its limits. Usually when the labor market gets very tight we see an increase in the length of the workweek, as employers struggling to find workers try to get more work out of the workers that they already have. We don’t see this story at all, the average workweek has fluctuated between 34.4 and 34.5 hours for the last four years, and it is down from peaks of 34.6 hours hit in late 2014 and early 2015.
In fact, the index of aggregate hours is up less than 0.3 percent since January. If we held hours per worker constant, this would translate into a 0.7 percent annual rate of job growth, or roughly 90,000 per month. It would be difficult to view this as excessive.
The job opening rate was at 4.7 percent in April, the most recent data available, but that is down slightly from 4.8 percent in several months last year and earlier this year. The quit rate in the Job Openings and Labor Turnover Survey is 2.3 percent, the same as it’s been since June of last year. This is relatively high for the survey, but still below the 2.5 percent peak in January of 2001. (The survey only began in December of 2000.) In the Current Population Survey, the share of unemployment due to voluntary quits jumped to 14.7 percent in June. This is also relatively high, but below the peak of 15.4 percent reached in April of 2000.
But the Fed’s biggest concern in determining interest rate policy is whether there are fears of increasing inflation. Here is where the case for a rate cut is strongest. Rather than accelerating, the pace of wage growth has actually been slowing slightly.
The year over year rate of wage growth peaked at 3.4 percent in February of this year. Since then it has edged down modestly to 3.1 percent. The story looks even worse if we take a shorter picture. The annualized rate of wage growth from the first quarter of 2019 to the second quarter was just 2.7 percent. Rather than picking up steam in response to a tight labor market, it seems that wage growth is actually slowing.
Turning directly to inflation measures, there is no evidence of inflation accelerating from rates that are still below the Fed’s targets. The overall CPI is up just 1.8 percent over the last year. The core CPI is up 2.0 percent. The core index also shows some evidence of slowing. The annualized rate of inflation in the core, comparing the last three months (March, April, and May) with the prior three months (December, January, February), was just 1.7 percent.
Even the little inflation seen in the CPI is largely due to housing costs, an area that is little affected by wage costs. The core index, excluding shelter (mostly rent and owners’ equivalent rent) was up just 1.0 percent over the last year. Comparing the last three months with the prior three months, the annualized rate for the core index, excluding shelter, was just 0.1 percent.
We get the same story if we look at the core personal consumption expenditure (PCE) deflator, which is the index for which the Fed targets 2.0 percent inflation. The year over year rate of inflation in the core PCE has drifted down from 1.8 percent in January to 1.6 percent in April and May. Again, there is zero evidence of accelerating inflation.
As many have pointed out, if the Fed is to maintain credibility on a 2.0 percent inflation target as an average, then there must be periods in which the inflation rate is somewhat above 2.0 percent. This means that it should actively desire some increase in the inflation rate.
It is also important to note on this point that there will be a recession at some point. This fact is relevant in this context, since we know that a recession will put downward pressure on the rate of inflation. If we were to enter a recession with an inflation rate under 2.0 percent, then we will be even further below the Fed’s target when the full effect of the recession is felt.
Of course a low inflation rate also makes it more difficult for the Fed to boost the economy by lowering interest rates, since we want a large negative real interest rate, which is not really possible if the inflation rate is very low. For this reason, a higher inflation rate provides us with more protection going into a recession.
In short, even with the higher than expected June jobs numbers there is still a solid case for further cuts in the federal funds rate. Insofar as there is a problem with inflation it is that it is too low, not that it is too high. Given this reality, there is not any obvious downside to cuts in the interest rate that should lead to more rapid job growth, and hopefully more rapid wage growth, which may lead to some uptick in the inflation rate. Lowering rates is a move that offers clear benefits, with no obvious cost.