The United States is experiencing an almost “too good to be true” economy. Unemployment just dipped to its lowest level since 1969, and inflation, while still uncomfortable, is cooling off. This is not supposed to happen. According to economics textbooks, there should be a trade-off where getting inflation down leads to layoffs and rising unemployment. Federal Reserve interest-rate hikes were expected to trigger job losses and a recession. Instead, this resilient economy even shows signs of a jobs boom. How is this possible?
One explanation could be that the data is wrong. There were a lot of adjustments to the January jobs report. Government statisticians fine-tuned the numbers on population size, immigration and how many workers typically exit jobs after the summer and winter holidays. It’s likely the 517,000 job gains will be revised lower. But revisions over the past two years have overwhelmingly shown more jobs added than initially thought, and hiring in recent months is clearly strong.
Another possible factor is all the government stimulus rolled out during the pandemic is still having an impact. The stimulus checks, unemployment money and child tax credit payments — plus the fact that many people stayed home for much of the pandemic — gave Americans unprecedented savings. That cushion helped people deal with rising prices. As their savings dwindled, people have been going back to work and scaling back spending. Workers ages 25 to 54 are now basically fully back in the labor force. On top of that, infrastructure spending is a boost to industries such as construction that might have otherwise seen a slump from the Fed’s high rates.
The most plausible explanation of all is that the pandemic and subsequent recovery were so unusual that the normal rules of economics don’t apply. Demand surged for everything from toaster ovens to used cars. Supply chains could not keep up. Prices spiked. Now, there’s a right-sizing. Goods inflation has come down for most items (even for eggs) as demand has subsided. The question is whether services inflation for travel, restaurants, entertainment, insurance and deliveries will follow.
Can this economy last? Last year, big companies had stellar profits with the fattest margins since 1950. Customers were willing to pay higher prices — often over the asking price — on homes, cars and more, and executives kept raising the bar. Fed vice chair Lael Brainard has dubbed this a “price-price” spiral. Some might call it corporate greed, but the usual price competition dynamics were temporarily suspended. Many companies were able to hire more workers, raise pay and still give generous returns to investors. Now, those profit margins are coming back down and executives are eyeing the “year of efficiency.”
This looks like a return to more normal economic times. Slimmer margins, Brainard argues, could contribute to disinflation.
“We’re coming down from such a high level that it’s not like this is a dire outcome for markets, investors or the economy,” said economist Julia Coronado of MacroPolicy Perspectives.
The key is what happens to wages. For all the talk of workers having so much power, union membership reached an all-time low in 2022, and wages for most workers have not been keeping up with inflation. Companies made hefty profits because they raised prices faster than their labor and other costs.
Coronado points out that perhaps the most surprising statistic is that workers have not gained a bigger share of the economic pie. The percent of economic output that goes toward worker compensation — the so-called labor share of the economy — has been trending down for decades. When the labor market gets tight, such as the late 1990s, the labor share ticks up. With unemployment at 3.4 percent, the labor share should be going up. Instead, it has been falling the past two years. The current level of 56 percent is not only below pre-pandemic levels; it’s back to 2014 conditions. This might help explain why most companies aren’t rushing to fire workers. Labor costs are up, but not to extreme levels.
This return to normal is helped by numerous tailwinds: Gas prices are back down, China has reopened and appears to be rebounding, and immigration is picking back up, providing more workers to fill job openings. Wage growth is also slowing down as workers aren’t quitting and jumping to new roles as often. This could keep inflation on a downward trend.
Put all of this together and the story is that employment remains strong, consumption is solid and businesses are growing cautiously more optimistic. Avoiding a recession, which seemed unthinkable only a few weeks ago, could be possible.