US Economy I: Yellen’s Slack. Fed Chair Janet Yellen isn’t just the Fairy Godmother of the Bull Market. She is also the Fairy Godmother of the Labor Market. In her 3/5/14 ceremonial swearing-in speech, she said: “Too many Americans still can’t find a job or are forced to work part-time. The goals set by Congress for the Federal Reserve are clear: maximum employment and stable prices. It is equally clear that the economy continues to operate considerably short of these objectives. I promise to do all that I can, working with my fellow policymakers, to achieve the very important goals Congress has assigned to the Federal Reserve.”
On 3/12/14, I wrote: “Fed Chair Janet Yellen is a card-carrying Keynesian. Members of this club have been frustrated that ultra-easy monetary policy hasn’t boosted aggregate economic demand sufficiently to close the output gap and boost inflation. While lots of stimulus was provided by the American Recovery and Reinvestment Act during 2009 and 2010, they bemoan that there has been too much fiscal drag since then. They conclude that ultra-easy monetary policy must be maintained for as long as necessary to close the gap.”
In her first press conference (3/19/14) as Fed chair, Yellen talked about her “dashboard” of key labor market indicators including the headline U-3 and broader U-6 unemployment rates. Also on the dashboard are the numbers of discouraged and marginally employed workers, as well as the share of the long-term unemployed. She said she saw progress in the labor market, but she also saw too much distress. She also mentioned the labor force participation rate, which might be falling for demographic reasons but still has a cyclical component, in her opinion. She has also been watching quit rates, job openings, and the hiring rate, which was still too low, in her opinion back then. (See our Yellen’s Dashboard.)
Most importantly, Yellen said that wage inflation should be running around 3%-4% given the increase in productivity. She noted that other than a small spike in one measure, wage inflation remained too low around 2%: “The final thing I’ve mentioned is wages and wage growth has really been very low. I know there is perhaps one isolated measure of wage growth that suggests some uptick, but most measures of wage increase are running at very low levels. In fact, with the productivity growth we have, and 2% inflation, one would probably expect to see, on an ongoing basis, something between perhaps 3% and 4% wage inflation; [that] would be normal. Wage inflation has been running at 2%. So not only is it depressed, signaling weakness in the labor market, but it is certainly not flashing an increase … and it might signal some tightening or meaningful pressures on inflation, at least over time. And I would say we’re not seeing that.”
Yellen suggested that the wage numbers indicated that there was too much slack in the labor market. In a 3/31/14 speech, she specified that she is watching hourly compensation in the Employment Cost Index and average hourly earnings for all employees in private industries. In a footnote, she observed that they’ve been increasing “no more than 2-1/4%.” In her press conference, she said they should be growing 3%-4%.
US Economy II: Yellen’s Workers. Since Janet Yellen’s inauguration as Fed chair, almost all of the indicators on her labor market dashboard have improved significantly. The only exception is the one that she believes is the most important, namely wage inflation. Turns out that she has been right about too much slack in the labor market notwithstanding the significant improvement in measures of employment, unemployment, job openings, quits, and hires. That’s evident in the 2.4 million increase in the labor force over the past six months through March, the best such performance since June 2000 (Fig. 1).
Yellen was right to expect that the civilian labor force participation rate might stop falling and might start moving higher as discouraged workers who dropped out of the labor force dropped back in when job opportunities turned more plentiful. This rate fell from a record high of 67.3% during the first four months of 2000 to a recent low of 62.4% during September. Over the past six months since then, it has risen to 63.0% (Fig. 2). This increase in the civilian labor force participation rate accounted for approximately 1.5 million of the 2.4 million increase in the labor force over the past six months, with the balance due to growth in the working-age population (Fig. 3).
Previously, Debbie and I noted that the official unemployment rate would be higher if the participation rate hadn’t fallen as much as it did during the current economic expansion (Fig. 4). For example, instead of 5.0% last month, when the participation rate was 63%, the jobless rate would have been 7.9% at a 65% participation rate.
Fortunately, but obviously not by coincidence, employment is increasing as fast as the labor force (Fig. 5). Over the past six months, both are up 2.4 million. One survey of consumer sentiment has shown that the percentage of respondents saying that jobs are plentiful has risen from a cyclical low of 3.5% during October 2010 to a cyclical high of 25.4% during March (Fig. 6).
I asked Melissa to have a closer look at the labor force surge of the past six months. She reports that it’s been broad-based:
(1) Contribution by age. The Bureau of Labor Statistics (BLS) reports seasonally adjusted data by age groups including 16-24 years old, 25-54 years old, and 55 years and older. Each of these three groups realized net labor force gains over the past six months. However, their increases weren’t evenly distributed. Prime-aged working people, i.e., 25-54 years old, contributed more than half of the overall gain. Older workers contributed about a third, while the younger ones accounted for the balance.
It’s good to see more prime-aged workers coming back into the labor force. Most of the decline in the aggregate participation rate prior to the latest recovery can be explained by two structural demographic trends: More young people seeking higher education and Baby Boomers retiring. The oldest of the Baby Boomers turned 54 just when the participation rate peaked. The decline in the labor force participation of those aged 25-54 (before the latest upswing) has been harder to understand. Now we may have part of the answer: Some of this group had been discouraged and dropped out, but are starting to look for jobs and are finding them.
(2) Contribution by gender. Women and men were almost evenly split in their contribution to the 2.4 million labor force upswing. Men boosted the labor force by 1.3 million, while women added 1.1 million over the past six months. Looking at the gender breakdown by age groups, a similar pattern to the overall trend can be seen. Both men and women realized net gains in the labor force most significantly in the 25-54 age group, followed by 55 years and older, with the 16- to 24-year-olds in last place.
US Economy III: Yellen’s Target. Yellen must be very pleased with this development. However, she won’t conclude that her ultra-easy monetary policy has succeeded until she sees wage gains of 3%-4% on a y/y basis. In the prepared text portion of her latest press conference on 3/16, Yellen said: “Of note, the labor force participation rate has turned up noticeably since the fall, with more people working or actively looking for work as the prospects for finding jobs have improved. But there is still room for improvement: Involuntary part-time employment remains somewhat elevated, and wage growth has yet to show a sustained pickup.” In response to one question on labor market conditions, she said that “there is certainly scope for further increases in wages.”
When might Yellen achieve her target for wage inflation? That’s a very important question, because that’s when she will be more willing to move ahead with monetary normalization, which her very dovish speech last Tuesday suggests she’s postponing for the time being. Obviously, we need to monitor the labor force data. Not until most of the labor-market dropouts have come back in and found jobs might wage pressures finally build. Job-seekers will certainly meet with favorable conditions given that job openings remained in recent record-high territory at 5.5 million during January (Fig. 7).
While the job openings rate is also at a record high, hourly compensation (i.e., including wages, salaries, and benefits) as measured by the Employment Cost Index rose just 2.0% y/y during Q4-2015 (Fig. 8). Average hourly earnings rose 2.3% y/y through March (Fig. 9).
Again, this may certainly reflect the slack in the labor market, as evidenced by the recent rapid influx of new and re-entering workers. However, while Yellen remains a believer in the Phillips Curve, Debbie and I remain skeptics about this inverse relationship between higher/lower wage inflation and less/more labor market slack. Other factors may keep a lid on wage inflation even as the labor market continues to tighten, including global competitive pressures, technological innovation, and corporate efforts to maintain profit margins.
US Economy IV: Yellen’s Puzzle. There is a puzzling disconnect between the strength of the employment numbers over the past six months and the weakness of real GDP. Over this period, payroll employment is up 1.5 million, while the household measure is up 2.4 million. That divergence is puzzling too, by the way. During Q4-2015, real GDP rose just 1.4% (saar), while the payroll and household employment measures rose 2.0% and 1.5% on a comparable basis. The Atlanta Fed’s latest GDPNowestimate is an increase of only 0.7% (saar) for Q1-2016, while the two jobs measures rose 1.9% and 3.9% during the quarter.
Consumers are certainly in good shape. Our Earned Income Proxy for private-sector wages and salaries in personal income rose 0.5% during March, reversing February’s decline, and was back at a record high with a gain of 4.2% y/y (Fig. 10). (See our Earned Income Proxy.) On the other hand, weighing on the economy are bloated inventories, weak capital spending, and flat exports.
Nevertheless, the employment data suggest that real GDP growth may be understated. It’s hard to believe that workers are in such great demand with their productivity falling. The problem may be in measuring output in the services sector. The ratio of real goods output in GDP to aggregate weekly hours remains on a rising trend (Fig. 11). The comparable ratio for services in GDP has been on a downtrend since late 2009.
A longer-term picture of productivity in the goods vs. services sectors can be constructed starting in 1948 using payroll employment in both sectors (Fig. 12). These productivity proxies show gains of 923% for goods and 75% for services since the start of the data. Services now account for more output than in the past. So if it is being measured accurately, the problem is a long overdue need for better productivity growth in services. On Thursdays, Jackie and I have been keeping track of technologies that may be about to dramatically disrupt existing markets and industries, particularly in consumer, financial, and transportation services.