trending Market Intelligence /marketintelligence/en/news-insights/trending/nT3L6V3y83K7jNjLK1U0jw2 content esgSubNav
In This List

Economists split on full employment progress, posing puzzle for Fed

Blog

Using ESG Analysis to Support a Sustainable Future

Podcast

Street Talk Episode 87

Blog

A New Dawn for European Bank M&A Top 5 Trends

Blog

Insight Weekly: US banks' loan growth; record share buybacks; utility M&A outlook


Economists split on full employment progress, posing puzzle for Fed

A report showing larger-than-expected jobs gains in February has revived an ongoing debate among economists: Is the U.S. economy at full employment?

The lack of consensus is critical because clarity would help guide the Federal Reserve on how quickly it should raise interest rates in the coming months.

By most accounts, the U.S. economy is close to maximum employment, with last month's unemployment rate of 4.1% again marking a 17-year low. But economists do not agree on an exact figure of full employment — the lowest level of unemployment that the economy can sustain without, for example, a major inflation spike.

Even economists at the Fed are unsure, with the central bank's most recent monetary policy report saying the labor market "appears to be near or a little beyond full employment," but adding there is "no way to know with precision."

SNL Image

Some, particularly those on the left, think the Fed should let the unemployment rate drop further before raising rates. The job market, they argue, has not fully recovered about a decade after the financial crisis, with some discouraged workers still on the sidelines and who might decide to return if employers offer higher wages.

Jared Bernstein, senior fellow at the liberal Center on Budget and Policy Priorities, said the latest evidence of labor market slack came in the March 9 report showing the U.S. economy beat expectations by adding 313,000 jobs in February.

"It's absolutely worth it to test how low [unemployment] can go because nobody knows, and there's still a significant group of people who have yet to benefit from the expansion," he said in an interview.

For example, although the black or African American unemployment rate has dropped sharply to 6.9% in Feburary, from more than 16% in the most recent recession, it is still far above the 3.7% unemployment rate for white Americans. During his Feb. 27 hearing in the House, Democrats encouraged Fed Chairman Jerome Powell to let the unemployment rate drop further in hopes that gaps between minority groups and whites narrow.

Other economists, however, warn of the potential consequences of letting the labor market tighten much further. Desmond Lachman, resident fellow at the conservative American Enterprise Institute, said that could lead to significantly higher inflation. If prices rise quickly enough, he said, the bond markets could worry about the Fed's credibility to handle inflation, and the market disruption could force the economy into a recession.

"It really is not in the interest of the American public to have the U.S. economy overheat," Lachman said. "They might benefit for a short while, while it's overheating, but then they're going to pay a very heavy price when the correction comes."

Powell said during testimony to the House his estimate for full employment would be "somewhere in the low fours," adding it could also be 3.5% or 5%. Two days later, he told senators "some continued strengthening in the labor market can take place without causing inflation."

His colleagues on the policy-making Federal Open Market Committee, which has penciled in three interest rate hikes in 2018, are not in full agreement on the issue. For example, Kansas City Fed President Esther George said last month the economy is already at or beyond full employment, while Minneapolis Fed President Neel Kashkari, after seeing the February jobs report, said on Twitter, "we keep saying we are at max employment and then all these people choose to work."

SNL Image

A key factor is the U.S. labor force participation which has not come close to reaching its post-recession levels. The figure rose in February to 63%, though that is still below the 66% rate before the recession.

Former Fed Governor Randall Kroszner, who is now an economics professor at the University of Chicago, said one reason is the aging of the U.S. population over the past decade. But that "doesn't explain everything," he said, noting younger workers' labor force participation rates also have not fully recovered.

Kroszner said those figures suggest the labor market has more room to improve. But the Fed also needs to stay ahead of the curve, he said, and "be vigilant about inflation" potentially rising faster than it would like.

"I think, so far, they're taking a reasonably balanced approach," he said.