September 01, 2023
The August jobs numbers were mostly good with one big exception, a 0.3 percentage point rise in the unemployment rate to 3.8 percent. This is still a relatively low rate. Coming out of the Great Recession, many economists argued that the unemployment rate could not get below 5.0 percent without triggering spiraling inflation, so an unemployment rate below 4.0 percent looks pretty good by comparison. In fact, this is our 19th consecutive month with unemployment below 4.0 percent, a record unmatched since the end of the 1960s.
While it’s hard to get too upset about the level of unemployment, a 0.3 pp jump in a single month is disconcerting. However, on closer look, the story may not be that bad. The jump in unemployment was due to a big jump in people in the labor force, not a spike in layoffs.
The labor force reportedly grew by 736,000 in August, which would come to 8.8 million at an annual rate. Needless to say, this did not really happen. There was no event in the world that would have plausibly led to this sort of leap in labor force participation, so we have to recognize that the differences in the household survey data between July and August were largely driven by errors in the data.
If we ignore the July to August change and just compare August levels with prior months, there does not look to be much cause for concern. There were 2,914,000 workers who reported being unemployed in August as a result of losing a job. That is up by almost 300,000 from the July level, but only 14,000 from the June level. In fact, it is actually 46,000 below the May level. Clearly, there is no evidence of a surge in layoffs driving the unemployment rate higher.
The main reason why unemployment is higher than earlier in the year is that more people report being unemployed who are reentrants to the workforce or new entrants. The number of unemployed reentrants in August was 150k above the average for the first seven months of the year, while the number of unemployed new entrants was 80k higher. Insofar as there is a story of higher unemployment in August it is one where the economy is not generating enough jobs to employ all the people entering the workforce.
But, other data don’t square with that story. Most notably, the establishment survey showed the economy generating 187,000 jobs in August. The numbers from the prior two months were revised down, so that the three-month average stood at just 150k, but even this figure implies a considerably faster pace than most projections of potential labor force growth.
The Congressional Budget Office (CBO) puts the potential growth in the labor force at less than 1 million a year over the next three years, which implies a rate of employment growth of less than 90,000 a month. So, if CBO is anywhere close to the mark, 150k jobs a month should be more than enough to keep the unemployment rate from rising. It’s also worth noting that the household survey showed employment rising by 220k in August.
The weekly data on new and continuing unemployment claims are also inconsistent with any appreciable rise in unemployment. The four-week moving average for new unemployment claims stood at 231k for the most recent week, which is lower than its been for most of the last five months. The number of continuing claims stood at 1,692k, the lowest level since the start of February. There is no evidence here of any uptick in the number of people having difficulty finding jobs.
Wage Growth, Productivity, and Inflation
The other big issue of concern with this month’s jobs report was whether there was evidence of faster wage growth, which could trigger a reacceleration of inflation. The news was clearly good on this front. Wage growth slowed modestly, with the three-month annual rate dropping from 4.9 percent in the three months ending in July to 4.5 percent in the three months ending in August.
This is probably still somewhat faster than would be consistent with the Fed’s 2.0 percent inflation target, but not by much. There were several periods in 2018-19 when the rate of wage growth approached 4.0 percent. There also is still some room for the profit share to shrink back to its pre-pandemic level, which means that we could have more rapid wage growth, without seeing it passed on in prices. And, we have even further to go with profit shares if we target the pre-Great Recession shares.
The only serious basis for Fed concern would be if wage growth seemed to accelerating. That is clearly not the case with the data in the Average Hourly Earnings series in the jobs report. Since this was the only wage series that had shown any evidence of acceleration, the Fed should be reasonably comfortable that accelerating wage growth will not reignite inflation.
The other piece of good news on the inflation front is that it seems that the strong productivity growth number we saw in the second quarter will be repeated in the current quarter. The index of aggregate weekly hours rose 0.4 percent in August, but that was after dropping 0.2 percent in July. It is on course to show a gain of 0.3-0.4 percent for the quarter, translating into an annualized rate of 1.2 to 1.6 percent.
GDP to date has come in very strong with the GDPNow model putting growth for the quarter at over 5.0 percent, as of August 31. That will surely come down with data from August and September, but if the quarter’s growth ends up over 3.0 percent, it will translate into another very good productivity number.
These data are erratic and subject to large revisions, but it is always good to have another quarter where productivity goes in the right direction. In any case, it is one more item arguing that the Fed can hold tight on any further rate hikes. All the data suggest that inflation is continuing to slow, with a drop in rental inflation, the biggest single component in the index, a virtual certainty given the slowdown of inflation in marketed units. Inflation may still be above the Fed’s 2.0 percent target by the end of the year, but it should be close enough that the Fed can declare victory.
There were many predictions of recession earlier in the year, given the Fed’s extraordinary pace of tightening. While it was certainly reasonable to worry about the impact of these hikes, it was difficult to see the path through which they would cause a recession.
The main channels through which rate hikes led to recessions in the past were a slowing of construction, especially residential construction, and a drop in net exports due to a rise in the value of the dollar. We have seen relatively little impact on either channel to date.
The rise in interest rates has reduced housing starts, which peaked at an annual rate of more than 1.8 million last April, and then fell to less than 1.4 million this spring. However, due to the huge backlog of unfinished homes created by supply chain problems, the number of units under construction is still larger than it was back in March of 2022 when the Fed started its rate hikes.
There is a similar story with non-residential construction. There had already been a big falloff in office and retail construction at the start of the pandemic, so these sectors had little room to fall further. On the other hand, the CHIPS Act and the Inflation Reduction Act provided a huge boost to factory construction. As a result, non-residential construction has been rising rapidly this year. In August, construction added 22,000 jobs.
Rate hikes have also not had the normal effect on the dollar for two reasons. First, the dollar had already risen considerably against other major currencies following the passage of the American Rescue Plan at the start of the Biden administration and then again following the Russian invasion of Ukraine. This meant that the dollar did not have as much room to rise further as would ordinarily be the case.
The other factor was the rise in interest rates by other major central banks. Since all rates were going up more or less together, the higher rates in the U.S. did not have much impact.
Without a rise in the dollar, there was no reason to expect the sort of fall in net exports that might ordinarily follow a sharp rise in interest rates by the Fed. Since there has been no major drop in net exports, there has not been a fall in manufacturing output and employment. The number of jobs in the sector rose by 16,000 in August.
With construction and manufacturing, the two most cyclical sectors in the economy, still adding jobs, it is difficult to see how we can get a recession. This doesn’t mean the Fed’s rate hikes have had no impact on the economy. They brought an end to the refinancing boom that had taken place in 2020-21. This directly had an impact on jobs by reducing employment in the financial sector. Jobs in credit intermediation and related activities are down by almost 70,000 from where it was in March of 2022.
The loss of this source of credit also likely had some impact on slowing consumption, as many people did cash-out refinancing, where they borrowed against their home equity to undertake a major purchase, such as buying a car or remodeling their house. In addition, some of the money people saved from lower interest payments would have gone into consumption.
However, this impact has been fairly limited, as consumption has continued to grow at a healthy pace based on real wage growth. In any case, it’s hard to see a recession in the cards.
Probably the biggest cause for concern would be further problems in the financial sector due to losses that banks have on their books from government bonds and other long-term loans. Write-downs on loans to commercial real estate will also be a problem.
For this reason, it would be great if the Fed could signal that it is at the end of its round of rate hikes. They obviously are concerned about declaring a premature victory in their battle against inflation, after being slow to recognize the problem, but they don’t somehow even the score by making a mistake in the opposite direction.
At the very least, Chair Powell should more explicitly acknowledge the progress made to date, as other FOMC members have done, most notably Raphael Bostic. Anything that can produce a modest reduction in long-term rates will reduce the risk of a financial meltdown that could pose a series problem for the economy next year.