In tomorrow’s jobs report, we could well see the headline unemployment rate nudge down to 6.5 percent. This is the threshold at which the Federal Open Market Committee (FOMC) of the Federal Reserve had indicated they may move the short-term policy rates they control up from zero, thereby providing less monetary stimulus to the recovery.
Easing back on this stimulus would be a mistake. The economy remains far from full employment, and the headline unemployment rate is far understating the degree of economic slack remaining in the economy. This is demonstrated by the 5.85 million “missing workers”—potential workers who, because of weak job opportunities, are neither employed nor actively seeking a job. Further evidence can be seen in the 7.7 million “jobs-gap”—the number of jobs needed to restore the labor market to its pre-Great Recession health. Subdued wage and price inflation measures provide yet more evidence. The year-over-year change in the “market-based” core price deflator for personal consumption expenditures fell to 1.1 percent for all of 2013. And just today, data on unit labor costs (a key predictor of inflationary pressures in the economy) indicated that these slightly fell in the last quarter of 2013.
It is true that fiscal policy will hamper growth much less in 2014 than it did in 2013 (to be clear—it will not aid growth, it will just drag on it much less than in the previous year). But it does not follow from this that monetary policy has obvious room to tighten, or that the economy is anywhere the point where policymakers’ priorities should shift from reducing joblessness and spurring growth and towards putting downward pressure on inflation.
Very good signals on these priorities were provided earlier today by William Dudley, President of the Federal Reserve Bank of New York and a member of the FOMC. Dudley argued that the 6.5 percent threshold was already “obsolete” and that the wider range of economic data argues against raising short-term rates. He also noted that the Fed has always reserved the right to look at a wider range of data than just headline unemployment when setting interest rate policy. This echoes remarks made by Fed Chair Janet Yellen last month during Congressional testimony. Yellen and Dudley are right—the 6.5 unemployment threshold is obsolete, and a broader set of economic indicators that show an enormous amount of remaining economic slack should be taken very seriously by the Fed.