Sources: BLS, BEA, Federal Reserve

Those great monetarist economists, The Clash, asked the relevant question years ago: Should I Stay or Should I Go? In Fed-speak, that’s: should I raise or should I hold?

Based on all kinds of incoming info and pressures, the Federal Reserve is struggling to decide when to raise the key interest rate they control, the one that they’ve held at about zero since late 2008. By mandate, the Fed must balance the goals of full employment and stable prices, and as the job market continues to tighten, they’re worried wage and price pressures will surface. So the debate comes down to will they raise at their mid-September meeting, or, based on a number of factors pushing the other way  — the absence of said wage or price pressures, global weakness, market volatility — hold until a later meeting.

“If they raise there will be trouble.
If they hold it will be double.”

There was a lot of talk about how the jobs report out Friday morning would play into the mix. The conventional wisdom was that a strong number on payrolls or a significant drop in the unemployment rate would push the Fed toward a September rate liftoff, and vice-versa.

Well, as is so often the case, the data failed to cooperate. We got a weak’ish payroll number (173,000) and a significant decline in the unemployment rate, which, at 5.1 percent, is now at what the Fed thinks of as the “natural rate”—the lowest unemployment rate consistent with stable inflation.

Caveats abound. You always have to down-weight any monthly number due to statistical noise. I handle this by taking rolling averages of recent months’ payroll gains. Do so, and you get an average monthly gain of 220,000 over the past three months, a healthy pace for job growth.

Also, these data are revised in subsequent releases, and there’s a pattern to August revisions: they’ve averaged almost 80,000 over the past five years, meaning that after the two monthly revisions, the original August payroll gain has been this much higher, on average.

All of which is to say while the payroll number came in below expectations, the Fed is likely thinking like I am, and viewing this as another month of solid job gains. That’s certainly what the equity markets are thinking, as they opened sharply lower on expectations that the Fed would raise rates sooner than later (the markets worry that the rate hike will slow the economy, add to volatility, and make bonds a little more attractive relative to stocks).

Then there’s the unemployment rate, which fell from 5.3 percent to 5.1 percent. In Fed-world, that’s full employment.

In the real world, it’s decidedly not.

Wage growth remains tame — remarkably so, given the low unemployment rate — and the labor force remains historically low, suggesting significant numbers of potential workers remain on the sidelines, creating downward pressure on wages and a downward bias on the jobless rate. The number of involuntary part-timers — those working part-time who want full-time hours — remains highly elevated at 6.5 million, though that trend, too, is moving in the right direction, down 700,000 over the past year.

The wage and price stories are particularly important in this Fed “clash” we’re going through. Inflation, using the Fed’s preferred measure, has, if anything, been growing more slowly, the opposite of what you’d expect if things are tightening up enough to warrant a rate liftoff.

Average hourly wage growth, which despite low unemployment has been stuck at around 2 percent for years now, is up 2.2 percent year-over-year, so not much to see there by way of acceleration. That’s over the past year, but has there been a more recent speed-up in wage growth? Nope. If we take an average of the wage over the past three months, and compare it to the average over the prior three months, the annualized growth rate is…wait for it…1.9 percent.

This all comes together in the figure above. There you see the actual unemployment rate hitting the Fed’s full employment rate, while wages and prices just putter along. There are thus three possibilities as to what’s going on here:

–the “natural rate” is lower than the Fed thinks it is;
–the actual unemployment rate is biased down by some of the factors discussed above: the depressed labor force, the elevated number of involuntary part-timers;
–their model is wrong and there is no such thing as a “natural rate.”

I’m inclined to believe all of these. Regarding the third one, which is perhaps the most incriminating, there’s still a correlation between prices, wages, and slack, but there’s way more to it than the simple model’s predictions. For example, severely diminished worker bargaining power must be in there somewhere, as well as racial and gender discrimination. Moreover, if there is a natural rate, no one knows what it is with anything like the degree of accuracy you would need for it to be a reliable guidepost

So, should they stay or should they go?

That’s actually an easy one. We’re clearly not at full employment so, especially given the absence of price and wage pressures, the correct answer is to stay hold for now.

That’s the answer for a data-driven Fed. For a Fed driven by other stuff — emotions, ennui, nervousness (“let’s just raise the damn thing already and break the suspense!”), nightmares from the late 1970s, or whatever…well, that’s a different story.