The labor market is still moving in the right direction, but has a ways to go before reaching full employment
The top line numbers from this morning’s jobs report suggest that the economy is moving in the right direction, but we need to see a whole lot more movement before we reach full employment. It’s hard to overstate how important true full employment is for workers. In the absence of substantive policy changes to restore workers’ bargaining power, a tight labor market is the one avenue left to improve living standards for the vast majority of workers and their families. In a full employment economy, there are fewer people lined up for every job and employers have to offer higher wages to attract and retain workers. So, it’s really important for the Federal Reserve to let the economy achieve not just a full recovery from the Great Recession, but also genuine full employment.
While payroll employment growth in 2015 was a bit weaker than 2014, we ended the year on high note. Payroll job growth in December was strong at 292,000 jobs. While average payroll growth in 2015 (221,000 a month) was still below 2014 (260,000), the last three months saw some decent acceleration. Fourth quarter job growth averaged 284,000, compared to 174,000 in the third quarter. I’m hoping this is an indication of stronger job growth in 2016. If that strong pace continues over the next year, we will return to pre-recession labor market health in the near future.
When that happens, we should see better and better wage growth. Nominal average hourly wage growth rose 2.5 percent over the year, which is still too slow, but there have been some signs it’s picking up. In each successive quarter of 2015, average hourly wage growth increased by 0.1 percentage points. I wouldn’t go so far as to say that constitutes substantial acceleration, but the rate of growth has indeed nudged up. It’s important to remember, however, that nominal wage growth is still far below target levels. We need to see stronger and more sustained wage growth, above 3.5 percent, before it would be safe to say we were at full employment and it would be appropriate for the Fed to act to raise rates.
The figure below shows year-over-year changes in nominal hourly wages for the last several years. It is clear that we are still below a target range consistent with the Federal Reserve’s 2 percent inflation target and 1.5 percent productivity growth. (Wage growth higher than 3.5 percent for a prolonged spell is likely necessary to allow the labor share of income to actually recover as well.)
Nominal wage growth has been far below target in the recovery: Year-over-year change in private-sector nominal average hourly earnings, 2007-2016
|All nonfarm employees||Production/nonsupervisory workers|
*Nominal wage growth consistent with the Federal Reserve Board's 2 percent inflation target, 1.5 percent productivity growth, and a stable labor share of income.
Source: EPI analysis of Bureau of Labor Statistics Current Employment Statistics public data series
Let’s unpack that target range a bit. The 3.5 percent nominal wage target embeds a 2 percent price inflation target that comes straight from the Fed. The Fed’s 2 percent inflation target is there for a reason—it gives them some room to cut real interest rates below zero if economic conditions demand it. If the target was closer to zero, there wouldn’t be any room to stimulate the economy below the zero bound on nominal interest rates in the case of a future downturn.
Therefore, when some commentators look at 2.5 percent wage growth and about a half percent inflation and say “so, real wages grew by 2 percent, what’s the problem?” they are missing the fact is that 0 percent inflation is a dangerous way to run the macroeconomy. We just spent 7 years with 0 percent nominal interest rates and a still too-slow recovery. Why would anybody want to make the zero interest rate bound more dangerous by adopting a lower inflation target? In fact, the Fed’s 2 percent price inflation target is probably already too low—but the proper target sure isn’t zero.
The less-certain part of the 3.5 percent nominal wage target is the 1.5 percent assumption on trend productivity growth. Productivity growth has come in substantially below this in recent years. But 1.5 percent is still what many forecasters have for the U.S. economy going forward. And there’s some strong reasons to think that lots of the productivity growth decline is cyclical and could rebound with a high-pressure economy.
All of which just gives us one more reason to be dogged in our quest for full employment. As we approach it, wage growth should continue to rise and potential output is likely to improve. Given these stakes, we should be pleased with the evidence that the economic recovery is continuing, and not do anything to stop this progress.