Some financial writers — most prominently Bloomberg’s Evan Soltas, but also Conor Sen and G.M. Robertson — are claiming that labor markets may be becoming tight, which more or less means that unemployment has become less of a problem.
Their evidence? Exhibit A is the number of people quitting their jobs. As Soltas points out, the relationship between the number of quitters and level of unemployment has remained stable since the 2008 crisis, meaning we're not seeing the kind of low quit rate that would suggest people are clinging to their jobs out of desperation. As Joe Weisenthal argues, "When the economy is bad, workers don't quit their jobs." Their argument is that more people are quitting to look for better jobs, an indicator of labor market health.
But does the quit rate really tell us anything about the tightness of the labor market? It tells us how many people are quitting their jobs, but there is a selection effect here. People who quit their jobs tend to be the kind who are skilled, confident, and happy enough to get a better one. That isn’t the whole labor market. Their actions don’t tell us anything about the less-secure people in the labor market — the almost four million who are long-term unemployed, for example. Arguing that the quit rate is an accurate reflection of labor market tightness is like arguing that sales of luxury goods are a good proxy for economic growth. It only tells us about the better-off.
I do agree with Soltas that the headline unemployment rate of 6.7 percent is an accurate reflection of the number of people looking for work — which some might consider a sign of tightness. Yet the number of people looking for work alone cannot tell us how much slack there is in labor markets. Growth remains very weak, far below the long-term trend, implying that there is still a lot of slack left in the economy.
Conor Sen’s points are more convincing, at least at first glance. Sen points to the fact that new unemployment claims and the ratio between job openings and job layoffs are back to their pre-2008 norms. Jobs are being created, and layoffs are slowing. So there is no doubt that there has been progress on unemployment. Both of these indicators show that the job market is in the midst of healing. But the elevated numbers of long-term unemployed, workers who have given up looking for a job, and part-timers who want a full-time job show that it is not near to being fully healed.
The response to this from those who argue for labor market tightness has been that these workers aren’t really part of the labor force at all, because nobody will hire them. "The large number of quitters," Soltas says, "only makes sense if the long-term unemployed and labor-force dropouts aren't competing with them." Indeed, employers are routinely discriminating against the long-term unemployed. But saying that those who can’t get a job aren’t really part of the labor market is pure defeatism, and is especially weird given that the Federal Reserve is finally beginning to make progress on long-term unemployment.
So why give up now? To worry about inflation. If the labor market is becoming tight, then inflation may be just around the corner, since a tight labor market will lead to wage rises, which they reason will in turn will lead to price inflation. The Atlantic’s Matt O’Brien rightly calls those arguing labor market tightness "the new inflation hawks." They think the economy can't grow as fast as it used to, threatening inflation, which means we need to get ready to raise rates.
But this is a weird time to be hawkish on inflation. Core PCE inflation — a less-volatile measure of inflation favored by many economists — remains close to the lowest it has been in 60 years, and almost a full percentage point below the Fed’s target of 2 percent. The more widely-used CPI also remains below target, and close to the lowest rate in 60 years. In other words, the cost of progress on unemployment clearly has not been excessive inflation.
And there's no reason to assume it will be, particularly since the task of getting unemployment under control is still far from complete, wage growth is actually falling, there are still huge deflationary forces in the economy, and we have Japan’s disastrous experience of tightening prematurely as a model.
The risks of being too dovish are minimal. If the Fed leaves rates too low for too long, the recovery will proceed to strengthen, the number of long-term unemployed will continue to sink, and wages and, yes, inflation will eventually pick up. This seems like a pretty rosy scenario. Rising wages will be welcomed by workers after years of stagnant wage growth. Excessive inflation is not desirable, but the Fed has an unprecedented number of tools to deal with inflation, including hiking interest rates and engaging in reverse quantitative easing.
The risks of tightening monetary policy too soon, on the other hand, are large. In a worst-case scenario, tightening while unemployment remains high and growth remains weak threatens to crash the economy back into recession and send prices into a deflationary cycle. After five years of slow but gradual progress, we risk sending the economy back to square one and falling into a Japan-style slump.
So giving up on the long-term unemployed is not only defeatist, but a highly risky move that would imperil the entire recovery. Let’s not make that mistake.