What to watch on Jobs Day: No evidence for another rate hike
Data on employment and unemployment in February will be released this coming Friday by the Bureau of Labor Statistics. Notably, this is the last jobs official jobs data we’ll get before the Federal Reserve meets in two weeks to decide whether or not to follow up December’s quarter point interest rate increase with another rate hike.
Forecasters are expecting Friday’s report to show quite weak performance in February, driven in large part by the major snowstorms that hit the East Coast during the week when jobs data was collected. However, even aside from expected temporary weakness, Friday’s jobs report is extremely unlikely to provide any strong evidence that the December rate hike should be followed with another increase in two weeks when the Fed meets again. In fact, data since the December hike contain mixed messages at best regarding the pace of recovery.
For example, after the December rate hike, data was released showing that gross domestic product grew at less than a 1 percent annualized rate in the last three months of 2015. Other data showed that the employment cost index, a closely-watched indicator of trends in labor costs pressure, grew just 2 percent year-over-year for the last quarter of 2015. And job growth in January was 151,000, down from the average monthly rate of 228,000 that the economy saw in 2015.
There have been encouraging (but quite small) upticks in some other economic data. Retail sales were strong in January. Core price inflation as measured by the consumer price index grew year-over-year in January at 2.2 percent, the fastest rate since 2012. (though Dean Baker highlights the role of rental price inflation in driving this, and the fact that attacking rental price inflation with higher interest rates is a flawed strategy).
Hourly wage growth (as measured by the data that will be released on Friday)has shown some mildly encouraging trends in recent months. Year-over-year growth seems to have moved finally above the 2.0-2.2 percent band that characterized most of the recovery, and has pushed close to 2.5 percent in recent months. But this is still far below wage growth that would characterize a genuinely healthy economy.
And this last bit is the rub of it: until wage growth is strong enough to consistently support overall price inflation of 2 percent, the Fed should forestall any further rate increases. Some might argue that because the economy’s trajectory has momentum and because there are lags between when the Fed begins to tighten and when the economy begins to slow that rate increases need to happen before wage and price growth consistent with the 2 percent inflation target happen. But this view presumes that the 2 percent price inflation target is a hard ceiling that should never be breached. And this is wrong—the inflation target should be seen as an average that holds over a multi-year period, and not as a hard ceiling.
Given that slack wage growth has dragged overall price inflation below the 2 percent target for a number of years, the Fed should actually aim for a period of wage and price growth that exceed their long-run targets. Such an extended period of above-target wage and price inflation could greatly aid a return to full recovery.
For prices, the benefits of restoring the price level to the point where trend 2 percent inflation throughout the recession and recovery would have taken it would greatly aid households who remain debt-heavy. Unexpected inflation erodes the economic burden of debt, while unexpected disinflation increases this burden. Imagine a household that took out a mortgage payment of $1,000 a month in 2006, expecting overall inflation to run at 2 percent each year. By 2016, they expected that the inflation-adjusted value of their (fixed) monthly payment would be significantly smaller—roughly $180 less per month, giving them an additional $2,000 or more each year to spend on other things. If, instead, inflation decelerated to 1.5 percent per month over the ten years, they would have about $500 less per year than they planned freed up by the declining inflation-adjusted value of their loan. A period of above 2 percent inflation would let their future spending possibilities get back on track.
For wages, growth that temporarily rises above the healthy-economy target is necessary to allow the share of domestic income going to workers’ pay to return to pre-recession levels. Over the course of the recovery, historically high profit margins and near-flat unit labor costs saw this labor share of income plummet to historic lows. If nominal wages only rise at the rate of overall productivity growth plus the rate of overall price inflation (the definition of the healthy-economy wage target), then today’s low labor share will be cemented as the “new normal.” Instead, we should let nominal wages grow faster than this target for a stretch and claw back some of the labor share declines of recent years.
Finally, even if this Friday’s jobs report unexpectedly shows strong growth, this does not mean that the Fed should raise rates again in two weeks. The risks to the economy going forward remain deeply asymmetric, with the risk of a slowing economy and excess unemployment causing much more damage than the risk of inflation moving above trend. Besides all of the reasons noted above about why a short period of above-trend inflation would be affirmatively good, the risk of excess price growth is so much less because the Fed still has effective tools to quickly tamp it down. The Fed has shown little ability to engineer rapid demand growth in the current environment (with unhelpful fiscal policy and very low interest rates and inflation). But nobody really doubts that the Fed could quickly slow the economy with a series of rate hikes.