Job Market in US – There may be some lingering slack FRBSF says

The U.S. economy is looking quite good. Growth is on a solid trajectory, and the FOMC’s maximum employment goal is in sight. Risks from abroad are unlikely to overturn strong U.S. fundamentals. Still, the exact timing of an initial interest rate increase will depend on convincing evidence that inflation is heading back toward target. The following is adapted from a presentation by the president and CEO of the Federal Reserve Bank of San Francisco to the International Conference of Commercial Bank Economists in Los Angeles on July 8.

Employment

Returning to the U.S., there were some concerns that the apparent slowdown in spending growth could spill over to employment, but the signs from the labor market have been consistently resilient and positive. Not only has there been solid job growth, but the data show most of those new jobs are full-time and higher paying. We have also seen a dramatic decline in long-term unemployment over the past few years. In fact, a wide set of measures of labor market conditions have continued to show improvement across the board.

Most importantly, our employment goal is in sight. Economists tend to think of full employment as having reached the “natural rate” of unemployment, the rate we should expect in a fully functioning economy. Most put it between 5 and 5.5%; my estimation, to be exact, is 5.2%. So, with the unemployment rate now at 5.3%, we are obviously tantalizingly close. My forecast sees the unemployment rate continuing to edge down, falling to around 5% by the end of this year, and even drifting slightly below 5% next year.

Of course, there are other measures of labor market underutilization. As I said, we’re making good progress across a broad spectrum of indicators. For instance, people who’ve dropped out of the labor force but still want to work. That figure has come way down and is now about where you’d expect it to be given the overall state of the labor market.

But there are other areas that suggest there may be some lingering slack. One is the still large number of part-time workers who would rather be full time. So-called involuntary part-time work soared during the recession and has remained unusually high during the recovery. The question we’re asking is: How much of that is due to an economy that still hasn’t reached full strength and how much is due to more persistent influences? Recent research by San Francisco Fed staff shows that most of the rise in involuntary part-time work was, in fact, related to the economic downturn. But there is an outside component—largely reflecting changes in industry employment shares and demographics—that may account for much, if not all, of the rest of it (Valletta and van der List 2015; see also Cajner et al. 2014).

We aren’t yet sure about the life span of these factors; they could dissipate over time, or they could reflect a permanent shift—another “new normal” of the post-recession world. But when you take them into account, they point to the current rate of involuntary part-time employment being more or less in proportion, slack-wise, to other indicators.

So, while I have the policymaker’s curse of approaching things with a certain amount of trepidation, it looks like the labor market is bringing home a good report card in just about every class.

Another positive sign is the recent increases in wages. For some time, there was concern that wages were somehow immune to the recovery’s positive influences. In fact, the stagnation in wage growth wasn’t particularly surprising, because history and experience show us that wages don’t usually start to pick up until the economy nears full employment (Daly and Hobijn 2014, 2015). Now that wage growth is starting to take off, based on the most comprehensive indicators, it offers further confirmation that the labor market is nearly healed. While businesses aren’t always thrilled about the prospect of paying workers more, this pickup is a sign of a healthy economy. It’s good for the labor market, household income, and consumer spending, and is therefore good for business. In fact, what’s really been missing in this recovery is wage growth of around 3 or 3½%. That’s the rate I’d expect in a fully functioning economy with a 2% inflation rate. Now we’re starting to see that come to fruition, and it’s a good sign.

The employment side of our mandate has made tremendous progress over the past few years, and taken together, all signs point to a labor market that is zeroing in on full employment.

However, as we make our way back to an economy that’s at full health, it’s important to consider what we should expect along the way. The pace of output and employment growth, as well as the decline in the unemployment rate, have slowed recently…but that’s to be expected. Last year the economy added slightly more than 3 million jobs. So far this year, we’re on track to add about 2.5 million, with a further slowdown likely. When unemployment was at its 10% peak during the height of the Great Recession, and as it struggled to come down during the recovery, we needed a fast pace of decline. With the goal in sight, however, the urgency is not the same. Then, we needed to create lots of jobs to get the economy back on track; now that we’re getting closer, the pace of job gains needs to start slowing to more normal levels.

Looking towards next year, what we really want to see is an economy that’s growing at a steady pace of around 2%. If jobs and growth kept the same pace as last year, we would seriously overshoot our mark. I want to see continued improvement, but it’s not surprising, and it’s actually desirable, that the pace is slowing.

Chosen excerpts by Job Market Monitor. Read the whole story at Federal Reserve Bank San Francisco | The Recovery’s Final Frontier?.