Watch out for wage growth pick-up and be careful about a recession is the message from the Goldman Sachs Economic Research team. The US economy is at full employment and the US Federal Reserve is more than justified to raise interest rates so as not to fall into runaway inflation, but all statistics are not lining up on one side of the argument — not yet.
Goldman: US economy is at full employment
“On a broad range of measures, the US economy is now at full employment,” Jan Hatzius and his research team wrote in an April 28 research note titled “Out of Room.”
As headline unemployment falls below most estimates of the structural rate, the report takes a look beyond the popular statistics and notes that unemployment among the often cited “discouraged worker” is down to pre-recession lows. Further, the “somewhat elevated share of involuntary part-timers,” those who want a full-time job with benefits but cannot find one “is arguably structural.”
Looking at the employment/population ratio, which is another attempt to validate the notion of “full employment,” this level remains well below its pre-recession level, the report noted. “The gap is fully explained by a combination of population aging and declining participation of prime-age men,” pointing to a trend among prime-age men has continued for over six decades. This data point has not impeded a strong near-term wage acceleration among such workers “and therefore looks structural.”
Economic indicators seldom line up in unison, a point that Goldman recognizes:
One potential caveat is that broader measures of labor market slack have sent a more downbeat message than the headline unemployment rate U3 earlier in this recovery. And unlike U3, the broad underemployment rate U6 still stands slightly above the levels seen in late 2005. The non-U3 components of U6 are marginally attached workers (people outside the labor force who want a job, are ready to start, and have searched in the past 12 months) and involuntary part-timers (people who would like to work full time but who can either only find part-time work or are on reduced hours because of slack work or business conditions).
Full employment & Wage growth expands
Wages are a key component of forecasting inflation. Goldman’s composite wage tracker now reads 3.0%, which is 0.25% below the investment bank’s estimate of a medium-term sustainable pace.
“With actual productivity growth weaker than our long-run trend estimate, unit labor costs have grown somewhat faster than the Fed’s 2% inflation target for the past three years,” the report said, looking at a potential inflation warning flag. “This reinforces our view that excess labor market slack has disappeared.”
When slack in employment markets disappears, workers typically have bargaining power with their employers and the related economic activity kicks up inflation.
Goldman’s analysis is that job growth is “well above” what is needed to stabilize unemployment, which leads to a mild warning of sorts. Hatzius and his team think the decline in the unemployment rate to just short of the FOMC’s estimate of its structural level “raises the stakes in the debate about labor market slack,” with different viewpoints.
“On the one hand, choking off growth too quickly would needlessly keep people out of work and could cap inflation below the 2% target,” but there is typically data that runs counter to beliefs. “On the other hand, keeping the foot on the gas pedal could lead to a more serious overshooting that might be difficult to reverse.”
The job of a central banker managing the world’s most prolific economy is not an easy one. In some respects it is like the three bears where success is not found in the extremes but in the middle getting things “just right,” a difficult task indeed.
Will the Fed Beat the Odds?
Most postwar US business cycles—especially those prior to the 1990s—ended when a sizeable rise in inflation forced the Fed to tighten monetary policy aggressively. But such sharp adjustments have been less necessary in the much more stable inflation environment of the past three decades—even in very strong labor markets. Many commentators are therefore skeptical of the notion that an overheating economy poses the same kinds of recession risks that an analysis such as that of the preceding section would suggest. As long as the Phillips curve remains as flat as it has been in the last two decades, the story goes, Fed officials can safely let the job market overshoot without undue recession risks.
In part, Goldman agrees with this analysis. If inflation is well-anchored, they reason, a central bank does not need to move as aggressively in response to cyclical pressures. “This means less risk of overtightening and pushing the economy into recession, and it means that gradually reversing a labor market overshoot is a more plausible scenario,” they wrote, pointing to the tight-rope that needs to be maintained.
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