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Friday, October 05, 2012

Fed Watch: On The Surface Better, But Underneath The Same

Tim Duy:

On The Surface Better, But Underneath The Same, by Tim Duy: The jobs numbers are out, and they are reasonably solid. Reasonably solid as long as you weren't expecting miracles. Very strong if you thought the economy was heading into recession. But just about where they should be if you think the economy is just sort of grinding along at a slow but steady pace.
Nonfarm payrolls gained by 114k, about consensus, but both July and August were revised, adding 40k and 46k jobs, respectively. As upward revisions tend to follow upward revisions, we can expect the final September number will print higher as well. The average of the past three months is 146k. The average of the past twelve months is 150k. In short, ignoring the twists and turns of the data leaves you with pretty consistent job growth over the past year:

Emp1

In my mind, the policy significance of the twists and turns is not so much that the economy was threatened with excessive slowing this spring, but that the Fed's anticipated acceleration in activity was to be unrealized. The continuation of slow and steady is what prompted open-ended QE (although the downside risks didn't hurt either).
Note that hours worked, which had flattened out, are again on the rise:

Emp7

Likewise, the unemployment rate unexpectedly dropped to 7.8% after holding steady for much of the year:

Emp5

Again, look through the twists and turns. On average, the economy is adding about 150k jobs a month. At the moment, holding the unemployment rate constant probably takes something closer to 100k jobs. As a consequence, the unemployment rate grinds lower.
This slow rate of unemployment decline presents some interesting challenges for policymakers. My first thought is that Chicago Federal Reserve President Charles Evans should be thankful that his colleagues did not take him up on his 7% target as minimum rate to consider a policy shift. We could get there sooner than expected. Evans should shift gears and join with Minneapolis Federal Reserve President Narayana Kocherlakota and his 5.5% rate (putting aside the issue of "price stability" for the moment).
Why is this important? Because 7% unemployment could be met with considerable slack left over in the labor market. Wage growth remains anemic, for both production and nonsupervisory employees:

Emp2

and all employees:

Emp3

A distressingly large portion of the unemployed are long-term unemployed:

Emp4

Those employed part time for economic reasons continues hold at high levels:

Emp6

And the employment to population ration remains stagnant:

Emp8

Bill McBride notes that there has been some gains in the employment to population ratio for persons in their prime working years (25-54), but much ground still needs to be covered.

The point is that it would be very likely premature to tighten policy even when the unemployment rate breaches 7%. But tighter policy may be needed before 5.5%. It is this kind of complexity that shows up in the minutes of the last Federal Reserve meeting as:

Many participants thought that more-effective forward guidance could be provided by specifying numerical thresholds for labor market and inflation indicators that would be consistent with maintaining the federal funds rate at exceptionally low levels. However, reaching agreement on specific thresholds could be challenging given the diversity of participants' views, and some were reluctant to specify explicit numerical thresholds out of concern that such thresholds would necessarily be too simple to fully capture the complexities of the economy and the policy process or could be incorrectly interpreted as triggers prompting an automatic policy response.

Admittedly, differentiating between cyclical and structural unemployment will become increasingly difficult as the unemployment rate continues to fall. I think that I would fall back on wage growth as a key signal of labor market tightness. Until wage growth is "substantially and sustainably" higher, we really shouldn't worry much about the inflation risk.

Bottom Line: A solid report, but basically consistent with the trends of the past year.

    Posted by on Friday, October 5, 2012 at 10:47 AM in Economics, Fed Watch, Monetary Policy, Unemployment | Permalink  Comments (31)

          


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