(Bloomberg) -- With every new round of job and wage figures, economists look for signs that the economy has reached full employment. That’s often described as the point where the only people who are unemployed are those temporarily in between jobs, and beyond which unemployment is so low that it sparks inflation. But unemployment has fallen further and faster in this expansion than many forecasters anticipated, without any sign of price pressures. That’s forced a major rethink in economics.
1. What’s supposed to happen at full employment?
It’s supposed to spur inflation: Low unemployment sparks employer competition for workers, wages are bid up and companies boost prices to recoup the increased costs, raising the risk of a so-called wage-price spiral. The idea of full employment was popularized by economists such as John Maynard Keynes and William Beveridge in the 1930s and 1940s, first amid the widespread unemployment associated with the Great Depression and then the very tight labor markets that came along with World War II.
2. What’s happened instead?
The unemployment rate has in recent years fallen below what many government policy makers, including those at the U.S. Federal Reserve, consider consistent with full employment, but inflation hasn’t gone up as they expected it would. Fed officials started wondering if the U.S. had reached full employment back in 2014 when the unemployment rate crossed below 6%. More than five years later, the rate stands at 3.5%, and the lack of inflationary pressures has them rethinking their assumptions.
3. What’s happening with pay?
That’s been the mystery. As the unemployment rate has dropped, the pace of wage growth has been slower than in previous economic expansions. Now, there’s a debate over whether the Phillips curve, a statistical relationship between unemployment and wage growth that’s guided policy makers and forecasters for decades, is broken. Economists remain on eagle-eye lookout for signals of faster pay gains, which is why stories like Taco Bell’s pilot program to raise manager pay to $100,000 in some locations draw such attention. But official statistics meant to capture overall wage growth across the entire economy suggest it’s been losing momentum. In 2018, average hourly earnings rose 3.3%, but in 2019, they climbed only 2.9%, despite a lower unemployment rate.
4. How could falling unemployment not boost wages?
One issue has to do with what’s being measured. The government counts as unemployed any person who doesn’t have a job, has “actively looked” for one in the previous four weeks, and is available for work. A wider measure of people who aren’t working, but want to be, would count people who aren’t actively searching for various reasons as well. Many people who lost their jobs in the 2007-2009 recession became discouraged and gave up looking for work, and it’s taken a long time to reabsorb them into the labor force. More recently, there’s been an increase in the number of people taking jobs after previously saying they didn’t want to work, a phenomenon that may also be keeping a lid on wage growth.
5. What does this mean for economic policy?
Low wage growth means inflation is likely to stay low, which means the Fed is unlikely to raise interest rates much any time soon. U.S. central bankers have been rethinking their standard approach of raising rates in anticipation of price pressures before actually seeing them bubble up; that line of reasoning got them in trouble with President Donald Trump in 2018 and ultimately played into their decision in 2019 to reverse some of the previous tightening. Meager wage growth is also playing into the U.S. presidential race, with Democrats citing it as evidence that the economy is not necessarily in as good a shape as the unemployment rate suggests.
The Reference Shelf
- The U.S. Fed is struggling to nail down the meaning of full employment.
- The Bureau of Labor Statistics has all the data.
- An article by economists at the Fed asks why wages have grown so slowly.
- A New York Fed working paper on the methods economists use to estimate the so-called natural rate of unemployment.
- A history of the Fed’s full employment mandate published by the Center for Economic and Policy Research
- A Bloomberg special report on would-be workers still left behind in 2017, “The New Face of American Unemployment.”
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