Video: What Unemployment and Wage Growth Signal about Inflation
Lord Abbett: The Investment Conversation
What Unemployment and Wage Growth Signal about Inflation
Ann Hynek: The U.S. economy has seen the unemployment rate fall to a mere 3.8%. We know that this is a key indicator for the Central Bank, when it comes to setting monetary policy, because the Fed's dual mandate commits it to seeking maximum employment and stable prices. Whatever the March jobs report brings, Giulio Martini takes a look at the underlying fundamentals, and explains how the Fed will be looking at the numbers. This is The Investment Conversation.
Ann Hynek: Hi, I'm Ann Hynek, here with Lord Abbett's Director of Strategic Asset Allocation, Giulio Martini.
And Giulio, first things first, what do we mean when we say the unemployment rate?
Giulio Martini: Well, first of all, hello, Ann, it's a pleasure to be here. And the unemployment rate is something that a lot of people hear about, but technically, what it measures is the percentage of the people in the labor force who don't have a job, but who have actively looked for one recently.
What it doesn't measure is people who might be available for work, but haven't actually done anything to look for a job recently. Or people who are working part time, but would rather be working full time. The version of the unemployment rate that steals the monthly headlines on the first Friday of every month is down to 3.8% [as of February 2019], which is very, very low.
The lowest it ever got in the previous economic expansion that ended in 2007, was 4.4%. And the lowest it's ever been, going all the way back to when the statistics began to be kept in 1948, was 2.5%. So we really have an unemployment rate that, by historical standards, is very, very low.
Ann Hynek: So that 3.8%, that number doesn't really reveal the whole picture, though, when it comes to the jobs report, right?
Giulio Martini: No, it doesn't. And in fact, I don't think it reveals just how tight the labor market really is right now.
There's another unemployment rate that goes by the statistical name of U-6, that does count the people who are available for work, but haven't looked recently, and people on part time, who would rather be on full time.
Giulio Martini: And that unemployment rate has come down from a high of 17.1% all the way back at the end of 2009, to only 7.3% today. And that's the lowest it's ever been. So not only are we running at a very low rate of people who are looking for work, but we're running out of people who might take on more work, but haven't really actively looked for it lately. So I think we're an even tighter situation that that 3.8% unemployment rate suggests.
Ann Hynek: So what, then, does that mean for the workforce?
Giulio Martini: Well, the good news is, that it means that 18 and a half million new jobs have been created since the economy started growing again in late 2009.
The bad news is that it's getting harder and harder for businesses to replace workers who leave, due to retirement, or to take on new workers that they need to grow their business.
The vacancy rate is at an all-time high. So the number of jobs that are unfilled, the number of people that employers would like to hire, but are unable to do so because they just can't find them is higher than it's ever been before, as a percentage of the civilian labor force. And that means that there's more and more wage pressure being created. And so what we've seen is wage growth accelerating to a much faster rate than we saw in the early stages of the current economic expansion.
Ann Hynek: At this point, we'd like to tackle three important questions about the labor market and labor costs. Why did it take so long for wages to start accelerating? How much longer can wages continue accelerating? And will it ultimately lead to increased inflation?
So, Giulio, why did it take so long for wages to accelerate?
Giulio Martini: Well, it really took so long, I think, principally, because of demographic factors. We have an older labor force than we've ever had before. There are more people employed who are 55 and older than we've ever had in history. And there are fewer employed who are 25 and younger than we've ever had in history.
That's important for wage growth, because older workers receive much smaller percentage wage increases than younger workers do. So as the labor force and the employment structure tilts towards older workers, it naturally just slows wage growth down. It slows wage growth down as well because older workers don't change jobs as frequently as younger workers do.
And people who change jobs receive much larger wage increases than people who stay in their current job. So the fact that we have an older workforce, and a more static, a less mobile workforce, really depressed wages for a long time.
The other important factor is that in the early stages of an economic expansion, the jobs that are being created are mostly at the lower end of the wage distribution.
Because those are the people who were laid off in greater proportions in the previous economic downturn. And so aggregate wages are really depressed because the largest amount of jobs being created in the early stages of the expansion are low wage ones.
But as the expansion continues and endures, there are more and more high wage jobs created. In part, because those people who took lower pay jobs move up in the wage distribution. But [also] in part, because you start needing more people at higher wages.
And that shift towards better, higher paying jobs accelerates aggregate wage growth. And that's what we saw start to happen about two years ago, and that's something that really has persisted, and it's really a good thing, because creating great jobs that pay a lot is a positive thing. But it also is something that's going to cause aggregate wage growth to accelerate.
Ann Hynek: For how long will wages continue to accelerate?
Giulio Martini: Well, I think they're going to continue accelerating for as long as the economy keeps growing. So for as long as this expansion lasts. And by the way, in July, it's going to become the longest one in U.S. economic history.
And wages will keep accelerating because as job creation shifts to higher paying jobs, it becomes harder and harder to replace workers at the low end of the wage distribution.
So their wages start to accelerate rapidly. But once the quit rate gets very high, which is what we're seeing, and vacancies are as great as they are, then we start to see wage pressure across the entire job distribution, in high paying jobs, as well as in low paying jobs.
And that's what the data is telling us. It's not just in one part of the job distribution, it's really become comprehensive across the job distribution. And as the quit rate rises, what you find is that employers not only have to raise wages to replace workers who leave, but also raise wages for their existing workforce, to try and cut down on turnover, because it's so hard to replace people when they decide to leave.
And so we're at that point where wage pressure is becoming comprehensive across type of job, and that's really going to continue for as long as the economy keeps growing. Because growth is going to require more bodies to keep output rising.
Ann Hynek: Will rising wages ultimately lead to inflation and lower business profits?
Giulio Martini: Well, the good news is that the answer to that is no. Rising wages lead to rising inflation, if they also cause production costs to go up. But if rising wages meet accelerating productivity growth, then we can have a situation where wages go up, but production costs stay constant.
Now, that's good news for companies, because it allows them to sustain their margins. It's good news for workers, because you're getting wage increases and pay increases without inflation eating into it. So [the] standard of living is going up. And it's something that keeps the Fed on the sidelines, because if inflation is not accelerating, there's really no reason to raise interest rates to prevent it from doing so.
So that's kind of a state where there are only winners. And in fact, rising productivity growth is something that, if the economy manages to recapture it, would, in a sense, be the best of all possible worlds.
Ann Hynek: So things seem pretty good right now. We have a rising standard of living, stable corporate profit margins, and low inflation. Can that continue as the labor market tightens? Tune in next time to the investment conversation to find out.
The U.S. Federal Reserve (Fed): The central banking system of the United States
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