Forgive me if I overuse this analogy, but I think it’s instructive. Think of the U.S. economy as a water glass. In bad times, the water doesn’t fill up the glass, leaving people “thirsty” for jobs, wages and incomes. In good times, the glass is filled to the brim, and households across the income spectrum handily slake their thirst. In overly good times — when the economy is operating beyond its capacity — the glass overflows.
In this analogy, spillage equals inflation. Instead of jobs and wage growth, we get higher prices. Your wage might grow a percent faster, but so does inflation, so your paycheck’s buying power is unchanged.
I raise this for two reasons. First, because too many of my economist brothers and sisters think the glass is already overflowing, i.e., that we’re at full capacity. Second, because today’s jobs report, featuring an above-expectations payroll gain of more than 300,000 jobs, suggests they’re wrong.
Now for some important caveats. It is a common — though misguided — practice to over-interpret monthly job reports. On last month’s jobs day, an apparent pop in wage growth (up 2.9 percent) triggered a big sell-off on Wall Street. Well, that pop was revised down slightly, to 2.8 percent, and this month’s figure came in at a moderate 2.6 percent. I will try to avoid that mistake in this analysis by focusing on trends, not single data points.
As is increasingly widely recognized, economists simply do not know the number that corresponds to the “natural rate of unemployment,” meaning the lowest jobless rate consistent with stable inflation. We basically have to infer the size of the glass from looking for spillage. That is, we figure we’re at capacity when more demand for goods and services mostly yields more inflation, not more output. That means those (like me) who claim the glass still isn’t full are stumbling about in the same darkness as those who claim otherwise.
But our evidence is better than theirs. Check out the figure below, which shows some of the key indicators used by the Federal Reserve to assess how much water is in the glass. The unemployment rate, at 4.1 percent in February, has been below the Fed’s guess at the “natural rate” for about a year. And yet inflation (PCE core, the Fed’s preferred gauge) continues to undershoot their 2 percent inflation target. And while yearly wage growth has picked up, as we would expect given the tightening job market, it has climbed from around 2 to 2.5 percent, where it has rested for about two years now.
This is not at all a picture of overcapacity. To the contrary: It’s a picture that suggests there may be more room to pour.
Another problem for the overcapacity crowd is the jobs numbers themselves. The 313,000 added jobs in February is an outlier to the upside that may well be revised down, but averaging over the past year, we’re still adding around 200,000 jobs per month. Typically, when the economy hits full employment, that number falls, as the labor pool can’t supply more workers to meet more demand.
So, we must entertain the possibility that something salutary may be underway: The long, strong labor market recovery is pulling more people in from the sidelines. In our analogy, the glass is getting bigger. If that’s what’s happening, it helps explain why team overcapacity keeps getting this wrong. They’re scrutinizing a glass that is smaller than the one that’s on the counter.
This possibility also means the unemployment rate, which doesn’t count sideliners, isn’t telling the full story. A better metric in this context is the prime-age (25-54) employment rate. It leaves out retirees and grows when people come off the sidelines to work. Its peak in 2007 was 80.3 percent, and its post-recession trough was 74.8 percent. Last month, it popped up three-tenths to 79.3 percent, and by now it has recovered 4.5 out of 5.5 lost points.
Given the size of population of these workers, that one percentage point left to claw back amounts to 1.3 million potential workers added to the labor force. If we dare to dream that a persistently, super-tight labor market could get this indicator back to its 2000 peak, that would add another percentage point, making it 2.6 million potential new workers, more than another year of 200,000 jobs per month.
I do not know if that’s possible, but absent an obvious spillage problem — which to be clear, doesn’t mean just a little more inflation (it means persistently higher price growth), for the sake of those millions of workers who’ve long been left behind — we must see how much room there is in a glass that may be getting bigger as we speak.