Effective full employment has probably drawn a bit closer

Friday’s jobs report showed a continued decline of the “employment gap”, as measured by my simulation of Blanchflower and Levin.  The official unemployment rate is now actually below the CBO’s estimate of the natural rate, while the spread between the participation rate and its presumed natural level continues to edge lower.  The number of people working part time for economic reasons has also been declining and is now near what B&L have somewhat-arbitrarily defined as normal.

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If the gap continues to close at the pace of the past four months, it will be eliminated by early summer. That is obviously false precision as these things are measured very loosely and the whole idea of an employment gap is itself controversial.

San Francisco  Fed President John Williams may be jumping the gun when he says flatly that the economy is already “operating above potential.” But on this metric at least, things have moved a bit more quickly than my simulations from a couple months ago implied.

The labor market tightening implied by B&L is not yet corroborated by a meaningful quickening of wage growth, which seems – understandably – to be providing some comfort in the bond market.  If wages were to begin to accelerate, then people would be much more concerned that the labor market was overheating. So I guess on Bayesian grounds, the absence of that development lowers the odds that we have already pushed to or through effective full employment.

On the other hand, the lead from achieving full employment to a quickening of wages could be quite brief.  This is not something on which I have a strong view.  The state of the art here is not that highly developed, so far as I can tell.

A couple months ago I mentioned that I would write a post going over the implications of the apparent decline of labor market slack.  I have failed so far to follow up, because other things have interested me more and because I am a bit of a multi-handed economist on this issue.  But here are a few interpretations offered as assertion and in point form:

Measuring the natural levels of unemployment and participation is not hard science or even best practice for social science. To the extent we use this concept to think about the inflation outlook, there is data mining involved, because estimates of the employment gap are themselves a function of historical inflation. It is good to be skeptical about this stuff, IMV.

One does what one can. Leaving aside the link between inflation and slack, the economy’s medium-term growth potential is more limited when labor resources are more scarce.  So any acceleration of demand growth from here would probably be self-limiting, in part (only) by provoking the Fed.

Somewhat related, the 2- to 3-year recession risk has risen, as the Fed’s priorities have shifted, and is probably now slightly above average. However, the approach of full employment has not historically been a pressing threat to the expansion, so far as I have studied (which is not fully).  And the economy does not now currently seem to suffer from major inflationary or real-side imbalances.  So, fwiw, I don’t see much reason to be alarmed by recent developments.

This would be an odd time to endorse fiscal stimulus on macro grounds, because there is no obvious deficiency of demand, as evidenced by the fact that the Fed is tightening. Were demand growth to be forced above its current trajectory, we would just get more tightening, rightly or wrongly. I would say rightly, but practically speaking it does not matter, unless you want to change the Fed’s mandate or leadership.

The tightening labor market slightly raises the urgency to tame demand growth to the economy’s apparently-reduced supply side potential growth rate, as mentioned. However, it does not follow from this that the Fed should follow the logic of the Taylor Rule or other reduced-form policy rules. That is a separate discussion.

I am sure MMT followers reading this post will be appalled and insist that this take is based on a flawed model.  Fine. We all have our models, whether they be mathematically formalized or more qualitative, as in my case.  I am not a fan of the MMT world view, as I have probably been clear enough about.  This post is not aimed at MMT. They are no more persuadable than I am on these issues.

In any case, there seems little need to pound the table here. As I read it, the current situation does not present an outlier.  We are arguably near full employment and the Fed is reacting appropriately cautiously to that.