Just Because the Engine is Running Doesn't Mean It Has Gas

Last week, in good news for everyone, the Bureau of Labor Statistics (BLS) reported a monthly net payroll gain of 321,000 in November and revised the gains for September and October by an additional 44,000. This means over the last three months, job gains averaged a little more than 278,000. That is a number big enough to finally bring down the unemployment figures in a meaningful way. And, it means this is the strongest year of job growth since 1998.

This is a call for elation on Main Street, because it means the recovery now is showing the kind of acceleration needed to get America back to work. It comes after a record string of 57 months with positive private-sector job growth. The initial response was exuberance on Wall Street, because the reality is that a healthy Main Street means a healthy Wall Street.

But, the exuberance on Wall Street was short-lived. Like the Grinch, the ever-present inflation "Chicken Littles" are scurrying about warning that inflation is just around the corner. These same naysayers are pushing hard to have the Federal Reserve quickly declare the economy is healthy and urging it to raise interest rates, or the sky will fall. This week Wall Street is in a slump.

This is a call for elation on Main Street, because it means the recovery now is showing the kind of acceleration needed to get America back to work. It comes after a record string of 57 months with positive private-sector job growth. The initial response was exuberance on Wall Street, because the reality is that a healthy Main Street means a healthy Wall Street.

But, the exuberance on Wall Street was short-lived. Like the Grinch, the ever-present inflation "Chicken Littles" are scurrying about warning that inflation is just around the corner. These same naysayers are pushing hard to have the Federal Reserve quickly declare the economy is healthy and urging it to raise interest rates, or the sky will fall. This week Wall Street is in a slump.

But, before giving in to the pessimists, let's look at the evidence at hand. The third quarter report from the BLS showed that productivity was up 2.3 percent. But, labor cost fell by 1.0%, because wages did not keep up with that productivity gain. Second quarter labor costs fell 3.7 percent, a huge revision downward from an initial report of 0.5 percent. So, despite the healthy gains in employment, productivity is outstripping the feeble movement of wages. This means there is no evidence this labor market is pushing wages above productivity gains, which would in turn force firms to raise prices to keep their profits up.

The continued health of productivity gains is also a sign that employers are finding workers who enhance their productivity; if employers were hiring workers with limited skills, there would be a dramatic slowing in productivity growth. That is, if firms were hiring workers who lacked experience, or lacked skills, it would cause firms to spend large amounts of time and expense on training, so hiring would be up but output per hour per worker would fall. This reinforces the sense of many that there are still lots of unemployed workers who are without jobs because employers have lacked the demand for products to force hiring workers to increase output, as opposed to the sense that unemployed workers are "structurally" unemployed because they lack the skills that employers need.

So, the pessimistic view that inflation is just around the corner is a far greater stretch of the available data than a view that we still have a ways to go to get back to full employment. And, full employment is to the benefit of everyone. It means we are running an economy that generates rising incomes for everyone. And, as the continued rise in productivity shows, it means we are doing a better job of allocating people to the right job.

But, if the pessimist view prevails, interest rates will begin to rise in anticipation of Federal Reserve policy. The problem here is that the pessimist want to have it both ways-arguing that the Fed's policy tool of the Federal Funds Rate (the cost of overnight borrowing by banks to meet reserve requirements) being kept at zero has been ineffective; and on the other hand that the huge increase in the money supply generated by Federal Reserve open market actions of buying bonds to keep bank reserves high threatens accelerating inflation. Well, the long period of zero interest has generated no meaningful inflation, and finally the labor market is showing signs of strength.

If it took what the pessimist view as extraordinary increases in the money supply and a prolonged period of the Fed Funds Rate being at zero to reach this point six years later, then what would it take for the Fed to rev up the economy again if it slows down? Let's put some gas in the tank and let the engine run before we risk finding out. That could be accomplished by the Fed now clearly announcing it will not be raising the Fed Funds Rate until wages are outstripping productivity and productivity gains stall.

ENDS

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