The Fed Is on the Verge of Making a Major Policy Error
We recently learned that “Total nonfarm payroll employment increased by 313,000 in February” in the U.S., according to the Bureau of Labor Statistics—which, when combined with the ostensibly big fiscal policy stimulus introduced in February, would seem to justify the Federal Reserve’s increasingly hawkish outlook on interest rate rises.
The Fed, newly led by Jerome Powell, looks set to hike rates as early as this Wednesday. Yet there is a lingering sense that the current strength in the U.S. economy is more apparent than real. The employment data is not as strong as it looks on the surface, nor is fiscal policy as stimulatory as has been commonly assumed. Hence, the country’s monetary authorities might well be on the way to making a serious policy error that could abort the economy’s momentum, just as some of the non-1% are finally beginning to experience tangible gains from the recovery.
Let’s break these points down in a bit more detail. First, last month’s “blow-out” employment number: On the face of it, the employment situation report is anomalous. We saw a huge jump in goods producing (100K), mostly construction (+61K). But in the service jobs sector, 124K of the 187K of jobs created were in low-wage/low-hours sectors (retail, admin/waste, leisure, and health care). That would largely help to explain why, in spite of such an ostensibly large gain in the nonfarm payrolls, wage gains remained virtually unchanged, with hourly earnings actually coming in below expectations (in other words, a surprisingly tepid number relative to the overall growth in jobs in February). And even as we are adding higher-wage construction and manufacturing jobs, the overall constellation of the data implies a continuation of change in the mix of American jobs toward low-wage/low-hours employment, which helps to explain the tepid wage increases.
In fact, a closer look at the data gives us a picture of an economy where discouraged workers are finally returning to the workforce. This is one of the takeaways one can draw from the three-tenths jump in both the labor force participation rate and the employment population ratio; it shows that a lot of people are being drawn into a more active, and therefore more hopeful, employment situation.
This also marks the first rise in the participation ratio since September 2017 in the wake of two strong months of employment growth. But as labor economist Bill Mitchell points out, “in assessing the overall state of the labour market, we have to bear in mind that the... [current] participation rate... [of about 63 percent] is still far below the peak in December 2006 (66.4 percent),” which implies that there is still a large portion of underemployed workers, whose re-entry into the workforce could easily act as a break on wage gains.
“Adjusting for the aging effect… the rise in those who have given up looking for work for one reason or another since December 2006 is around 3.7 million workers.
“If we added them back into the labour force and considered them to be unemployed (which is not an unreasonable assumption given that the difference between being classified as officially unemployed against not in the labour force is solely due to whether the person had actively searched for work in the previous month)—we would find that the current US unemployment rate would be around 6.23 percent rather than the official estimate of 4.15 percent.”
Now, 6.23 percent is certainly not a disaster by any stretch (especially compared to where we were in 2009, at the height of the Great Recession), but it hardly constitutes “full employment.” Nor is it indicative of a “red-hot economy” that is about to burst into inflationary flames unless the Fed douses it with further monetary tightening. Furthermore, if one examines even broader classifications of labor underutilization, the so-called U-6 measure (“Total unemployed, plus all marginally attached workers plus total employed part time for economic reasons, as a percent of all civilian labor force plus all marginally attached workers”), that stands today at 8.2 percent, marginally above the 8 percent rate reached prior to the onset of the 2008 crisis. Again, this illustrates the real costs associated with the Great Recession.
We should also highlight that the job gains remain concentrated in the bottom segment of the workforce, which places minimal pressure on overall wage gains, meaning that the Fed’s hawkishness could abort any real wage gains. To go further into Mitchell’s analysis, for the vast majority of the workforce, there have been virtually no wage gains to speak of:
“Production and nonsupervisory workers have barely seen movement in their hourly wage outcomes over the last several years (note the BLS revised the January growth figure down in the latest release)…
“Total nominal average hourly earnings rose by 2.5 percent in the 12 months to November 2017, then 2.7 percent, then 2.4 percent, then 2.5 percent in the 12 months to February 2018.
“The unrevised January figure was 2.9 percent and it was this acceleration that led commentators to introduce on the ‘wages breakout’ thesis. The problem is that they didn’t examine the data carefully enough even before the data revision.
“Production and nonsupervisory employees accounted for 103,681 workers in February 2018 in the non-farm sector. Total private non-farm employment in February 2018 was 125,819.
“In other words, 82.4 percent of private US non-farm employment are accounted for by production and nonsupervisory employees… for these workers—the predominant majority in the US labour market—wages growth has been largely flat since 2013 with a dip in 2015.”
The other story, of course, has been the fiscal stimulus. The Republican tax giveaway is now swinging into effect, with a drop in income and corporate taxes by $21 billion from the year before, along with tax cuts largely tilted toward the wealthiest. This additional stimulus is undoubtedly a factor behind the Federal Reserve’s predisposition to hike rates more aggressively, based on the premise that the tax cuts and additional funding measures introduced to prevent another government shutdown last month will in aggregate introduce huge new inflationary pressures at a time when today’s measured inflation is running at around 2.2 percent.
But as in the case of the latest employment data, the manner in which the government’s fiscal resources are being deployed must be assessed more closely before racing to such conclusions. As we have noted before, “a large chunk of the latest tax cuts still goes to groups with the largest propensity to save, rather than spend.” Speaker of the House Paul Ryan inadvertently gave the game away on the Trump tax bill when he celebrated the example of a worker who would gain an additional $1.50 per week, which as Paul Krugman wryly observed, is “roughly the price of a small French fries at McDonald’s.” Maybe great for McDonald’s, but hardly likely to set the U.S. economy alight with huge inflationary pressures.
So after a decade of financial contagion, trillions of dollars of lost economic output, stagnating wages, and growing inequality, we’re still nowhere close to full employment, and we have a tax reform that largely confers benefits on those with the highest savings propensities. Given the extent to which income has stagnated over decades, a huge number of households have had to rely on debt and draw down their savings in order to be able to afford expenses such as housing, health care and education. The shared prosperity of the post-World War II era is but a distant memory. For the present, most of the private debt that we had in 2007 still exists. Some of it has been repaid, and there have been some defaults, but the bulk of it is still around.
Higher interest rates may be the trigger that halts the economy’s momentum, but it is important to note that the rentier style of capitalism that aided and abetted financial instability, wage stagnation and inequality has not been significantly transformed post-Great Recession. If anything, big banks have become bigger and their trading activity in exotic derivatives is as strong as ever, and there is a lot of masked leverage in the system. Yet policymakers quiver because of a marginal uptick in wages for the bottom rungs of our society, demonstrating little concern for how badly skewed the fruits of this “recovery” have been. And maybe that’s not by miscalculation. The dirty little secret of our economy is that policymakers have used “an army of unemployed” as a means of moderating wage pressures, thereby helping to perpetuate an economic model that is ultimately unsustainable. Perhaps we have to wait for an actual new Great Depression for this particular dynamic to change in a meaningful way.