What is a good monthly U.S. payroll number?

October 3, 2014

During a recent visit to my son’s dorm room, I noticed a test paper atop the rubble. It was marked with a score of 150 points out of a possible 200. When I confronted him about it, he was quick to reassure me that the professor grades on a curve, and his mark represented a “B.” But he is a pre-med student, and I told him that his future patients probably would not be happy with a misdiagnosis rate of 25%.

After reflecting on the situation for a while, I came to the conclusion that there are times when it is more valid to judge numbers in relative, not absolute, terms. Such is the case with readings on the U.S. job market, where our sense of what constitutes an acceptable result needs to change with the times.

Job growth was exceptionally robust during past expansions. During the 1980s, there were 23 months where more than 300,000 positions were created. In the 1990s, there were 28 such months. So for those of us who remember those eras, a monthly gain of that magnitude became a benchmark.

But we only had eight months where new employment exceeded that level in the 2000s, and we’ve only had four such months in the current decade. Since the labor force has been growing pretty consistently during the past 30 years, this seems especially disappointing.

The relative strength of U.S. economic growth certainly explains some of the divergence across decades. Annualized quarterly growth exceeded 3% in the 1980s and 1990s but has struggled to sustain even a 2% pace since then. This has contributed to a sense among policymakers that getting payroll expansion back to the “good old days” is simply a matter of bringing activity back to its old norms. Yet this has proven difficult to do, even with unprecedented levels of monetary accommodation.

Complicating the picture is the fact that American unemployment has fallen by 2% over the past two years, in spite of tepid monthly job gains by historical standards. Upon reflection, economists have concluded that the historical standards should be questioned, not the strength of payroll growth.

It’s a matter of basic math. Annual population growth in the United States is about half of what it was 25 years ago. Birth rates have fallen by 25% over that period; increased immigration has helped offset this somewhat. Projections for the coming five years from the Census Bureau call for about 2 million new members of the non-institutional population annually. Keeping the unemployment rate even would therefore require the creation of 160,000 jobs every month.

But then one has to account for declines in the labor force participation rate (LFPR). Participation has fallen steadily since 2000 and with increasing speed since the 2008 recession. A main driver is the retirement of America’s baby boomers, a total of almost 79 million people. This cohort will be leaving the workforce in increasing numbers over the coming decade.

Forecasts from the Bureau of Labor Statistics anticipate that the LFPR will decline by another full percentage point over the next five years. When you net this negative trend against meager population growth, the labor force is expected to grow by less than 1 million people annually. Keeping the unemployment rate constant would therefore require payrolls to expand by only about 80,000 each month.

Of course, a constant unemployment rate is not what we are after. Aside from bringing the overall rate down, we are also hoping to reduce the community of discouraged workers who have temporarily left the labor force. But monetary policy may be limited in its ability to achieve this aim.

It has been getting much more difficult for workers who have less than a college education to remain fully engaged. One driver of this trend has been globalization; basic manufacturing jobs, once plentiful and lucrative here in the United States, have largely moved offshore. The housing boom of the last decade may have masked the impact somewhat, as gains in construction jobs helped offset the loss of factory work. But since 2008, both have been depressed.

The key to improving the lot of those who have been displaced is to improve their education levels. Re-training can be financed by the worker, a firm or the government. If economic growth strengthens and wages begin to improve, all three might look on such an investment more favorably. This is the outcome that the Federal Reserve is hoping to engineer, but it may need help from other policymakers.

In light of all this, perhaps it is better for us to grade the monthly employment numbers on a curve, specifically the one depicting trends in labor force participation. That might not raise the rating of our current expansion to an “A,” but it should prevent people from seeing it as a complete failure.

September Employment Situation: Hiring Strong, Wages Subdued

The unemployment rate declined two notches to 5.9% in September, the lowest since July 2008. Strong gains in employment and a slightly lower participation rate accounted for the lower jobless rate. The participation rate has been nearly steady at 62.8% for six straight months. Therefore, the drop in the unemployment rate from 6.3% in April to 5.9% in September reflects an increase in employment, not people departing the labor force.

Payroll employment advanced 248,000 in September, and revisions added 69,000 more jobs to the readings for July and August. The six-month moving average of hiring gains stands at 245,000, nearly the best on record for the current expansion.

Gains in employment were widespread, with construction employment moving up 16,000 and factory hiring increasing 4,000. In the service sector, the 35,000 increase in retail sector employment reflects a return of striking workers. Excluding this one-off event, hiring rose across components of service sector employment – business services (81,000), education and health (32,000), leisure and hospitality (33,000), temporary help (19,700), and government (12,000).

There are more labor market indicators flashing green on Fed Chair Janet Yellen’s dashboard than a few months ago, but others continue to be problematic. First, hourly earnings are stubbornly stuck around 2.0% year-to-year gains versus 3%-4% increases seen before the recession. Wages are barely keeping pace with inflation.

Second, the number of part-time workers is 7.1 million or 4.8% of total employment, a notable improvement from 7.9 million a year ago. However, part-time jobs hit a low of 2.9% of total employment in 2007, implying this number needs to shrink more. Third, long-term unemployment as a percent of total unemployment rose in August (31.9% versus 31.2%). Finally, nearly 3 million people who are not in the labor force would like to work, compared with 1.8 million in 2007.

Taken together, the numbers suggest the Fed will note the progress in labor markets but not be overly moved by it. And as we discuss below, other considerations may take precedence in its policy deliberations.

Inflation: Missing the Target

Earlier this week, President Charles Evans of the Federal Reserve Bank of Chicago made a compelling case for the Fed to be patient before it commences normalizing interest rates. At the center of his argument were readings on inflation and inflation expectations that offer support for the Fed to defer prospective tightening.

The personal consumption expenditure (PCE) price index, which the Fed favors, was flat in August, putting the year-to-year gain at 1.5%, down from 1.6% in the prior month. The core PCE price index, which excludes food and energy, was unchanged at 1.5%. Both these readings are well below the Fed’s 2.0% inflation target.

The United States is not alone in this regard. Viewed across major economies, a disinflationary trend seems to be in place. Slow global growth has created idle capacity and taken pressure off the prices of goods and labor.

This is also reflected in inflation expectations. Market data show a declining trend in recent weeks.

There are several factors holding down inflation expectations. In the United States, the dollar continues to rally against major currencies and suggests lower import prices. The prices of oil and non-oil commodities are trending noticeably lower. This is due, in part, to downward revisions to the outlook for China’s economy and soft incoming economic data for the eurozone.

So inflation and inflation expectations do not seem to signal a threat. In fact, they seem to be headed in an even more-benign direction. For central banks that have a 2% target, the current condition can be viewed as underperformance that should be addressed with sustained levels of accommodation. And that may allow the “doves” to continue to win the day.

© Northern Trust

© Northern Trust

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