Concerning economic policy, it’s back to the future. As the unemployment rate (5.5 percent in March) has dropped, there’s been a shift in language. We’re told increasingly that we should aim for more than job growth. Our goal should be “full employment.” This recalls an earlier era, the 1960s and ’70s, when the pursuit of “full employment” (originally defined as a 4 percent unemployment rate) was the dominant target of economic policy. The quest ended unhappily: a wage-price spiral peaking at 13 percent inflation in 1980.
No one wants to repeat that debacle. But today’s full-employment advocates say the Federal Reserve can safely emphasize job creation over containing inflation, in part because inflation is so weak (overall consumer prices show no increase in the past year). Also, it’s argued, the recovery hasn’t been strong enough for workers to receive significant inflation-adjusted wage increases. The Fed should maintain its ultra-easy money policy until higher wages or prices indicate that the economy is bumping against its production limits.
Here’s how economist and former treasury secretary (under President Bill Clinton) Lawrence Summers has put it: “The best social policy is a high-pressure economy in which firms are chasing workers rather than workers chasing jobs.”
“[We favor policies that] get us to and keep us at full employment, by which we mean a very tight matchup between the number of people who want and need to work and the number of jobs. [This ensures] ... that the benefits of the economy’s growth don’t just accumulate to the top ... but are broadly shared by families at all income levels.”
Although the full-employment push comes heavily from liberals, some Republican and nonpartisan economists make similar arguments. The period from 1995 to 2000 is often said to epitomize the high-pressure economy. During these years, inflation-adjusted median wages grew an average of 1.5 percent annually compared with no gain from 1979 to 1995, says the liberal Economic Policy Institute. “The late 1990s,” it argues, “was the only period between 1979 and 2013 when wage growth was robust and broadly shared.”
What to make of this?
First, let’s admit that we don’t really know where “full employment” is. Economists define it as the “natural rate” of unemployment: the rate when tight labor markets begin to generate higher wage inflation. The Fed’s estimates of today’s “natural” rate range between 5 percent and 5.2 percent unemployment. At 5.5 percent, we seem close.
But suppose the natural rate is nearer to 4 percent. If so, we’re not so close. Despite the label, the natural rate isn’t natural. It reflects laws (say, the minimum wage), institutions (unions) and worker behavior. At any time, the natural rate is an educated guess based on past relationships that could be outdated.
The “Great Recession” might have reduced the natural rate. If workers worry more about job security — as seems likely — companies can pay less to keep them at their present jobs. Similarly, some economists argue that there are millions of labor dropouts who are not counted as unemployed but who would accept a job if it were available. Both these behavioral changes would depress the natural rate. But there’s no consensus among economists.
Next, wages. Some economists act as if any pickup in wages signals an inflationary breakout. That’s simplistic. The inflation that ultimately matters is in retail prices for groceries, utilities, electronics and more. Wage gains don’t automatically cause higher prices. Some gains can be offset by greater business efficiencies; competitive pressures and squeezed profits can limit other price increases. That’s what we want: wages to represent real gains in purchasing power. Only when wage gains become so large that they are passed along in higher prices — otherwise firms risk failing — does a wage-price spiral begin.
Given the uncertainties, the Fed should now err on the side of job creation. Inflationary pressures are scant; the economy’s strength seems fragile. Call it “the pursuit of full employment,” or whatever. It merely acknowledges that the economy is still recuperating from the “Great Recession.”
But we shouldn’t delude ourselves: What’s justified in the short run won’t work in the long run. Ensuring permanent “full employment” in a “high-pressure economy” is a seductive goal. It’s also utopian. It exceeds our powers of economic management.
The promise of constant full employment poses internal contradictions. If people believe that prosperity is guaranteed, they will behave in reckless ways that destroy prosperity. This happened in the 1960s with inflationary psychology, in the late 1990s with the tech bubble and in the 2000s with the housing crash. Societies that sow unrealistic expectations will reap destructive disappointments.
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