The job market is improving, but low labor force participation is still holding us back

August 11th, 2015 at 2:12 pm

Something odd is happening in the U.S. job market.

The rate of unemployment is falling, and doing so pretty quickly (see first figure), to levels approaching the Federal Reserve’s estimate of full employment. That is, the Fed says full employment corresponds to a jobless rate of 5.1 percent and the unemployment rate last month clocked in at 5.3 percent.

Source: BLS

Source: BLS

Underemployment (aka “U6”), a broader measure of slack which counts involuntary part-timers (who want, but can’t find, more hours of work), has been falling even faster than the topline rate. Job growth is trucking along at a nice clip too, with employers adding about 240,000 jobs per month on net over the past year.

All good, right?

So why is the damn labor force participation rate (LFPR) stuck in the mud? And why aren’t we seeing much in terms of wage growth?

On the first point, the LFPR—the share of the population working or looking for work—topped out at around 66 percent before the recession and was last seen stuck at 62.6 percent, the lowest it’s been since the late 1970s. That’s partly a benign function of the aging workforce, as we baby-boomers age out of our working years.

But there’s also a far less benign cause: persistently weak labor market demand that’s led a bunch of working-age people to sit out the job market. One way to see this is to take the retirees out of the picture, as economist Elise Gould does in this post. The share of employed prime-age workers (those between the ages of 25 and 54) is climbing back to its pre-recession level, but it’s still only about halfway there.

Low labor force participation can make the unemployment rate a less reliable indicator than it otherwise would be. If you’re out of the labor force, you’re not counted as unemployed (because you’re not, by definition, looking for work). But if you’re one of those people who could get pulled back into the job market if you saw some welcoming opportunities, then you ought to be counted as contributing to the slack.

This “shadow slack” that doesn’t show up in the unemployment rate has a lot to do (as work by economists Danny Blanchflower and Adam Posen indicates) with the fact that, despite the trends you see in the figure above, wage growth remains mired at around 2 percent. That is, with the un- and underemployment rates falling so much, you’d be well within your rights to expect to see wages accelerating beyond the 2 percent anchor they’ve been pretty much stuck at for about five years.

To show you what I mean, I’ve employed a very simple model of wage growth based on underemployment (see data note below). As you see, the model tracks wage growth pretty well, generally catching turning points.

Source: See data note.

Source: See data note.

However, based on the assumption—one in which I’m pretty confident—that underemployment continues to decline at the rate you see above, this model predicts wages should be growing at a pretty good clip by now, which they ain’t much doing. Chair Yellen considers 3.5% to be the non-inflationary rate of nominal wage growth, which is around where this forecast ends up.

But this out is probably too optimistic re future wage growth because it leaves out the low labor force problem. Adding the labor force to the model (as Posen and Blanchflower found) makes it track recent flat-lining wage growth more closely, and, under the assumption that the labor force rate remains where it is right now, even while underemployment continues to decline, the forecast shows a later and shallower liftoff.

lfwg3

Source: See data note.

These simple models are all speculative, of course. If the job market heats up and more sideliners find work, the LFPR would improve, as would the chances for faster wage growth. But as Yellen herself said last month, “The lower level of the unemployment rate today probably does not fully capture the extent of slack remaining in the labor market–in other words, how far away we are from a full-employment economy.”

That sort of thinking, along with being correct, suggests that if the Fed must raise interest rates, they should do so slowly and carefully, with a close eye on those who still don’t have much to show from the current recovery.

Data note: The wage variable is year-over-year percent change in a combination measure of four wage/compensation series: average hourly wage of non-supervisory workers; Employer Cost Index, average compensation and average wage; and median weekly earnings for full-time workers. The wage series in the figures uses principal components analysis to weight the underlying component series. Copying Goldman Sachs (GS) analysts, I start with their “non-linear wage Phillips Curve” model, which regresses the wage series on underemployment and underemployment squared. For the projection to 2017, underemployment continues to decline at its recent rate until hitting 9 percent, which GS considers the full employment rate for this variable. For the LFPR simulation, I hold the labor force constant at 62.8 percent, its quarterly value since 2014Q2.

 

In play to boost its exports, China devalues by almost 2%

August 11th, 2015 at 9:32 am

I had a feeling this was coming (from last April):

For reasons having to do with the current policy push [in China] toward more internal investment and consumption, their currency does not appear to be misaligned (artificially low) relative to the dollar, but if they should decide that their slowing growth rates are unacceptably low, they will devalue and that will hurt us.

Another interesting aspect of this are the linkages between the U.S. dollar, the Chinese yuan, and various offer currencies. The NYT points out that both the Australian dollar and the South Korean won fell by 1.1% and 1.4%, respectively. That’s part of what happens when you’re the primary global reserve currency.

In arguments about currency during the TPP debate, claims were made that a) China’s currency was not misaligned (true) and thus b) their management of their currency was a thing of the past (not true). This reminds us that whatever happens with the trade agreement, we need a strategy to deal with countries that manage their currencies. This event is a reminder that there’s no reason to ignore these concerns.

china_dev

Smell something, say something: there’s been no upsurge in undocumented immigration

August 7th, 2015 at 12:29 pm

Jon Stewart: “The best defense against bullsh__ is vigilance. So if you smell something, say something.”

I can think of no better guideline for what we’re trying to do here at OTE, so let’s take Jon up on his parting lead to us and post a couple of pictures regarding a point that most of the candidates were absolutely hammering on in last night’s Republican primary debate: the problem of unauthorized, or illegal immigration.

What no one mentioned was that the number of unauthorized immigrants has stabilized, and in the case of Mexico, is actually falling, as per the following two figures from the Pew Research Center. Certainly the impression left by the debate was that this situation is worsening. It is not.

First, here are the levels in unauthorized immigration, which leveled off a few years ago, meaning the net inflow (inflow-outflow of unauthorized immigrants) is around zero.

pew1

The data on undocumented immigrants from Mexico comes with more of a lag, but the most recent data shows net inflows have been negative, i.e., the number of undocumented Mexicans is declining.

pew2

Now, you might object to these levels of unauthorized persons here in the U.S. If so, you might also take some solace from the fact that they’ve stabilized in general and are falling re Mexicans. You might conclude, contrary to the rhetoric from the R’s last night, that our border patrol efforts are working.

But any implication that these levels have been rising as an increasing number of immigrants come to America without authorization is wrong.

Like the man said: smell something, say something.

Jobs Report for July: Solid job gains, no wage pressures

August 7th, 2015 at 9:25 am

Payrolls increased by 215,000 last month and the unemployment rate held steady at 5.3%, according to this morning’s jobs report from the BLS. It’s a solid report, showing that the labor market continues to gradually tighten. Yet by a number of important metrics, most notably the absence of faster wage growth, the report suggests that the job market’s steady progress is not generating inflationary pressures.

Most industries added jobs, revisions added 14,000 jobs to May and June’s tallies, and average weekly hours ticked up slightly. The share of involuntary part-timers, an important indicator of slack, fell slightly, to 6.3 million. That’s still an elevated number for this measure, but it’s down by over 1 million workers from a year ago. Thus, the more inclusive underemployment rate, which includes part-timers who want full-time work, ticked down to 10.4%, the lowest it has been since June 2008.

At the same time, the closely watched wage gauge remains stuck in neutral, up 2.1% over the past year.  What about more recent trends? If I average the wage over the last three months, and take an annualized growth rate over the prior three months, I get…wait for it…1.9%.

In other words, by this, and by the majority of other wage metrics, the tightening labor market is not creating inflationary wage pressures.

Why not? One reason is that the job market is not as tight as the 5.3% unemployment rate implies. The historically low labor force participation rate was unchanged in July, after falling 0.3 tenths of a percent in June. And while underemployment is coming down, it’s still elevated.

Thus, the message to the Fed re the job market: love it and leave it alone. The ongoing recovery is generating a steady flow of job creation with no obvious evidence, either in actual data or expectations, of the need to “tap the brakes” with a rate hike.

Employment increased broadly across the industries (64% of industries added jobs, an uptick from the prior two reports). Though the strong dollar has been holding back jobs in export sectors in recent months, manufacturing did a bit better in July, adding 15,000 jobs, exclusively in non-durables (durable manufacturing shed 8,000 jobs). Still, thus far this year, factory jobs are up by about 50,000 compared to over 100,000 over the comparable period last year.

The monthly smoother shows average monthly employment growth of 235,000 over the past three months, and longer look-backs show job creation to have settled into a trend comfortably north of 200,000/month.

smoother_8_15

Source: BLS, my calculations

One way to get a sense of how job growth has evolved over time is to dig into the OTE archives for smoothers from the past. The next figure shows how if you go back a few years, to 2012 (averaging over the same months as the above figure), you see job growth coming in at lower levels and decelerating. The six month average over the summer of 2012 was about 150,000 per month, about 50K below today’s six-month average.

smoother_arch

Source: BLS, my calculations

 

The Fed and the current job market:  certainly one of the biggest outstanding policy issues for the US job market and economy more broadly is when (and how fast) the Fed will raise the interest rate it controls (the Fed funds rate, or FFR) to slow the economy down in order to meet their dual mandate of full employment amidst stable prices.

I’ve scratched my head over their apparent urgency in this regard, and today’s jobs report.

The figure below shows a number of key variables in this debate. The straight line is the Fed’s estimate of the unemployment rate consistent with full employment—the rate at which price growth should stabilize around their target of 2% (their price gauge is the core PCE). The figure includes the actual unemployment rate, including today’s number, and also wage growth (wages and prices show year-over-year growth).

Sources: BLS, Federal Reserve, BEA

Sources: BLS, Federal Reserve, BEA

The strong expectation—really, the heart of the macro model driving the way economists think about all this—is that as the economy approaches full employment, prices and wages should accelerate. Thus, the Fed needs to tap the brakes to maintain its targets. In this regard, the straight line in the figure, the Fed’s estimate of the so-called “natural rate,” is like a sign on the highway saying: Slow down! Danger ahead!

But as the figure reveals it is a misleading sign, a poorly calibrated one. Prices and wages are not responding in the predicted manner so something fundamental is off about the model.

Surely, the Fed has to try to see around corners—they must be as much or more concerned with expectations as with actual outcomes. But there’s not much to see there either.

That said, they’re set on raising, and raise they will, probably either in their next meeting in September or December (and in this link I offer a rationale: perhaps they want to achieve a perch for the FFR before the next downturn). I don’t think a small bump up in rates will make a big difference to growth and jobs—certainly markets are expecting it.

But the key re future rate hikes is, if not “one and done,” than “one and look around patiently to see its impact.” If you must tap the brakes, I can’t stop you. But today’s jobs report shows a labor market that’s cruising along safely below the speed limit. Not everyone’s quite enjoying the ride yet, as the recovery has yet to boost the rate of wage growth. If next month’s report is a lot like this one, I’d at least wait until December for liftoff. Then I’d chill.

Actual GDP, meet Potential GDP

August 6th, 2015 at 8:17 am

I recently posted a “letter to the Fed” wherein I questioned the rationale for raising interest rates given a variety of economic developments that I argued offer no compelling reasons to tap the brakes on growth.

Here’s a point I made in that post, regarding GDP growth: “the current economy is like a slow runner who still hasn’t caught up to a goal line that’s moving closer as she runs towards it.”

Someone reasonably asked me what the h-e-double-hockey-sticks I was talking about. So let me try to unpack that bit of econ word salad. It’s all in the figure below.

act_pot_GDP2

Source: BEA, CBO

To underline what this is all about, you only need to wrap your head around two concepts. The first one is simple: real GDP, just the good old value of the goods and services that comprise the U.S. economy, currently around $17 trillion in today’s dollars.

The second one is a bit more obscure but very important. So-called “potential GDP” is what the value of the economy would be if it were firing on all cylinders, meaning all available resources were being utilized in producing the national product.

Consider a runner who sprained her ankle. Her actual speed, reduced by the injury, is analogous to GDP in a recession or weak recovery. Her potential speed is how fast she can run when she’s healthy.

OK—almost there, but one more important point to consider. Depending on the severity of her sprain, her potential speed could be reduced even when she’s fully recovered—the injury could have done permanent, or at least, lasting damage.

It’s the same thing with the macroeconomy. If the depth and length of the downturn is such that resources—people, machines, “animal spirits”—deteriorate more than they would have otherwise, that can lower the potential growth rate.

The analogy breaks down a bit here because benign factors, like the aging of the workforce can also lower potential. Moreover, the CBO assigns most of the reduced potential to “reassessed trends,” just a more pessimistic outlook re hours worked and productivity that they believe predated the Great Recession. Instead of spraining her ankle, our econo-runner could just be getting older and slower. That’s certainly been my personal experience.

At any rate, that’s what happened to the U.S. economy in recent years. My own view is that the weaker trends grow out of some less benign developments, like the deleveraging from the housing bubble, austere fiscal policy, stagnant earnings, and high inequality. Either way, the potential growth rate of GDP has slowed considerably.

Back to the picture. The top line shows the path of potential GDP that we thought prevailed back in 2007. Based on estimates of labor force and productivity growth at the time, if you asked a standard-issue macroeconomist back then where real GDP would be today, this is the line she would have showed you.

The next line shows the results of same exercise, but eight years later. By 2015, analysts had significantly marked down GDP growth, based on the fact that the labor force had contracted more than they thought back in 2007 and productivity growth was slower.

That’s bad in the sense that slower growth means less income relative to the higher 2007 potential, but here’s the punchline: six years into this recovery, actual GDP still hasn’t caught up to potential, even while potential has declined.

Before you go to the political place–Obama’s lousy recovery!–it’s important to note that the length of time it takes actual GDP to catch up with potential has been growing in recent decades. Our recoveries have become more L-shaped than V-shaped, an interesting change that’s a story for another day. (Also, Obama gets a big asterisk on this issue as Congress has consistently blocked his economic plans since 2010.)

At any rate, if you think of “actual” rejoining “potential” as a simple goal of a recovery, we’ve been running slow enough that we haven’t crossed the goal line yet, even as the goal line has been moving towards us. My letter to Yellen and co. explores the policy implications of that realization: it’s hard to look at the picture and see a strong rationale for break tapping.