The labor market remains seriously out of balance, and the Federal Reserve is not likely to relent so long as this remains true.
Nonfarm payrolls grew by 223,000 in December, the Labor Department reported on Friday. The unemployment rate dropped down to 3.5 percent. Both the rise in job and the decline in employment exceeded consensus forecasts, demonstrating once again that the labor market is far more resilient than most economic models suggest.
The total level of unemployed persons in the U.S. fell to 5.7 million, matching the post-pandemic record low hit last July. It is also tied with the prepandemic record low hit in February 2020. Prior to those moments, unemployment has never been so low in this century. It was only during the height of the dot com bubble on the 1990s that the level of unemployment got so low. Before that, you have to go all the way back to the 1950s, when the population and the labor force were much smaller, to find a period in which so few Americans were looking for work but unable to find a job.
The ratio of job vacancies to unemployed persons rose to 1.8 percent, indicating that the labor market tightened even more in December. This is a measure of labor market imbalance that has frequently been cited by Fed officials as a reason to worry about inflation.
The payrolls report confirmed the picture of the labor market painted this week by the higher-than-expected job openings figure, the surprising jump in the ADP private payrolls data, and the plunge in unemployment claims. Despite the Federal Reserve raising interest rates by more than four hundred basis points last year, the appetite for workers remains extremely robust.
This is a bit of a mystery. Public opinion polls indicate that many Americans think we’re already in a recession. Surveys of professional macroeconomists show that most believe the economy will enter a recession sometime this year or early next year. So why are employers still hiring at such a frenetic pace?
Labor hoarding is quickly becoming the fashionable explanation. The idea is that the memory of struggling to rebuild payrolls after the initial lockdown layoffs is still fresh in the memories of many managers and owners. To avoid being caught short of workers, some businesses may be keeping their workforce levels high even if demand is sagging. Many businesses have likely concluded they can keep workers on the payrolls through a brief and shallow recession—although surely a deep or long-lasting downturn would force layoffs.
The absolute level of employment may also be a factor here. Although businesses have been hiring at a rapid pace, employment still is not significantly above the prepandemic level. As the long-run chart below shows, employment remains well below where it would be if we had returned to the prepandemic trend. Many businesses still do not have as many workers as they did before the pandemic. What’s more, the economy is 18 percent larger than it was at the end of 2019, which means we’re producing a lot more with around the same level of workers.
There was some talk on Friday that the report could justify hopes for “immaculate disinflation” and the mythological “soft-landing.” The disinflationists pointed to a decline in average hourly wage growth to support this idea. Indeed, year-over-year wage inflation has come down from 5.6 percent nine months ago to 4.6 percent in December.
While wage gains have moderated, the Fed is unlikely to take much comfort from this. Wage gains still remain much higher than would be consistent with the Fed’s two percent inflation target. And the further tightening of the labor market—especially the openings to unemployment ratio—suggests that wage gains will accelerate. From the Fed’s perspective, the easing of wage gains will not create room for easing the tightening cycle. It will take a downturn in job gains and job openings.