The Magic of a Full-Employment Economy

Federal Reserve Chair Jerome Powell is nobody’s idea of a radical. But in his speech last week to the Economic Club of New York, he articulated an idea that upends generations of conventional wisdom and sets the stage not only for the Fed’s approach to the current economic crisis but also for President Joe Biden’s.

“A strong labor market that is sustained for an extended period can deliver substantial economic and social benefits,” Powell said, “including higher employment and income levels, improved and expanded job opportunities, narrower economic disparities, and healing of the entrenched damage inflicted by past recessions on individuals’ economic and personal well-being.”

It’s an intuitive idea. But it’s strikingly different from what’s in most advanced economics textbooks. The basic point is that the long-term health of the economy is determined by things like the progress of technology, the accumulation of capital goods, the quality of the workforce and the efficacy of regulations. The ups and downs of the business cycle are described as mere “fluctuations” in a continuous growth trend.

In this model, large fluctuations with big inflationary ups and deep recessionary downs are still bad, because normal people have a limited ability to insure themselves against these risks. The ideal is to shoot for is something like “The Great Moderation” of 1982 to 2007, when fluctuations were small.

With his $1.9 trillion Covid relief and stimulus package, Biden is not shooting for something moderate. As he said, “the biggest risk is not going too big, if we go, it’s if we go too small.” When a politician says this kind of thing — prioritizing short-term boosts over long-term growth — it worries adherents to the fluctuation school. In fact, one of their great 20th century projects was to create operationally independent central banks precisely to prevent it from happening.

Which is why it’s striking to hear Powell agree. In a key line from his speech, he referred to the strong labor market prevailing in the winter of 2019-2020 and noted that, during this period, “inflation did not even rise to 2% on a sustained basis.” In fact, he said, “the labor market could have strengthened even further without causing a worrisome increase in inflation were it not for the onset of the pandemic.”

That’s an unmistakable (if wonky) shot at the Congressional Budget Office, whose estimates say even in retrospect that the U.S. economy was operating at above its long-term potential all throughout 2018 and 2019. Those who say Biden’s stimulus plan is too large cite the CBO’s numbers. The stimulus only needs to be large enough to bring the economy back to the sustainable labor market conditions of December 2017, they say, not the “too hot” economy of February 2020.

But Powell and Biden’s economic team (which includes, among others, Jared Bernstein, the author of two good books making the case for robust full employment policies) see things differently. They believe a full-employment economy generates sustained social benefits.

In his speech, Powell spoke in detail about one — racial equity. “Black unemployment has tended to rise more than overall unemployment in recessions but also to fall more quickly in expansions,” he said. The dynamics of racial discrimination at work here are the kind of thing that don’t make it into abstract economic models but are clearly visible in the data: When labor is scarce, the benefits accrue disproportionately to the marginalized. That principle applies not just to Black workers but more broadly to people with criminal records, past troubles with addiction, or spotty work records.

That’s good for them, obviously — and the country, too. It’s clearly socially desirable for people fresh out of prison to be able to find a job. But most companies are reluctant to hire them. Government programs aiming at connecting ex-cons with job opportunities can fill the gap, but politicians will naturally be reluctant to go out of their way to help criminals find jobs.

By contrast, the cold logic of the market can do some good here. Precisely because nobody really wants to hire former prisoners, they are available to do less pleasant or less remunerative work. But that’s only true under conditions of full employment.

The benefits over time are considerable: Not only safer streets and more stable communities, but also reduced racial discrimination in the labor market. To adherents of the fluctuation theory — call them fluctuationists — these kinds of benefits are a hard to see. Fluctuationists also err in seeing human capital as something separate from the business cycle. Years of low unemployment and rising wages create a situation in which front-line supervisors who are good at training inexperienced workers are more valuable. A tight labor market is an incentive for firms to invest more in on-the-job training.

Last but by no means least, full employment feeds back into politics and culture in ways that economic models can too easily neglect. If paranoia about the availability of work is widespread, then bloated public investments and inefficient government programs can be easily defended as “job creation.” Even worse, rent-seeking regulations — whether in the form of occupational licensing or protectionist tariffs — are difficult to dismantle when saving jobs is the priority.

A politics that prizes efficiency but is indifferent to the losses experienced by workers and their families is doomed to fail. But a politics of full employment is one in which a focus on efficiency is viable. By “going big” on both fiscal and monetary policy, Biden and Powell are betting that rapidly putting Americans back to work will generate compounding benefits for long-term growth.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Matthew Yglesias writes the Slow Boring blog and newsletter. A co-founder of Vox and a former columnist for Slate, he is also host of "The Weeds" podcast and is the author, most recently, of "One Billion Americans."

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