With yet another “critical” employment report soon to be released, it seems appropriate to consider some longer-term issues. Here’s one recently raised courtesy of the Federal Reserve Bank of Chicago: “What level of job growth is needed to lower the unemployment rate?”
For decades the rule-of-thumb for economists has been that job growth needs to total 150,000 per month just to keep the unemployment rate from rising. Of course, the actual job growth needed can vary greatly depending on where we are in the economic cycle - discouraged workers leave the labor pool during economic downturns, while an economic recovery attracts new entrants. Consider, for example, the current cycle. The unemployment rate peaked at 10% in October 2009 and has since fallen to 7.6% in May of this year. That relatively sharp decline in the unemployment rate was achieved even though payroll growth averaged only 137,000 per month over that 44 month period. The explanation for that is simple: The potential labor force grew very slowly and labor force participation rate fell to a 30-year low.
The question for analysts is: Should the old rule-of-thumb be discarded as simply outdated? A recent paper from economists at the Chicago Federal Reserve sheds light on this issue (www.chicagofed.org). Their modeling suggests that secular shifts in labor force demographics and slower population growth mean that job growth of only 80,000 per month will allow for a further whittling away at the unemployment rate. And, by 2016, they believe that job growth of only 35,000 per month will produce a steady unemployment rate. Several economists (including me) would argue that the trend employment rate calculated by the Chicago Fed is too low, but there is general agreement that the old 150,000 per month figure is too high.
Here are some of my thoughts after reading this research paper:
- Focus on the doughnut, not the hole. I have always found that new and used vehicle forecasting models are better-structured when the variable input is employment (the doughnut) as opposed to the unemployment rate (the hole). And, of course, the theoretical underpinning is much sounder – the employed buy vehicles, not the unemployed.
- The Fed’s 6.5% threshold may be closer than we think. If even slow employment growth can, in fact, significantly lower the unemployment rate, then the Fed’s 6.5% guideline for reversing course on quantitative easing is not that far off.
- Pockets of labor shortages may be imminent. Given that the unemployment rate today for college graduates is only 3.8%, a significant fall in the overall unemployment rate would mean many more job openings for which there are few qualified applicants. In other words – slow employment growth, but a tight labor market. That’s a prescription for stagflation.
- Structural deficits will far exceed current government estimates. The biggest negative implication contained within the Chicago Fed’s study is what it means for fiscal policy. The unsustainability of the status quo with respect to entitlements becomes clearer, the window to address it becomes narrower, and chasm to be crossed widens.