Job Market Benefits From Growth
As the unemployment rate has moved below 6% in the United States, many commentators have sounded renewed alarms that inflation is about to quicken. These concerns were also heard when the dollar started to fall sharply in late 1985 and when oil prices started rising in late 1986. Although we are hardly in a period of price stability--the consumer price index rose by 4.5% between late 1986 and late 1987--these earlier alarms proved largely false. And last summer, in reviewing prospects in this column, I concluded that inflation is not heating up, but it is warming.
Is it now time to amend that verdict? And is it time for monetary policy to tighten so as to slow down an overheating economy?
Historically, as unemployment rates have declined to low levels, wages and prices have risen faster. This empirical relationship, which economists know as the Phillips curve, is by no means all there is to predicting inflation.
Indeed, during the 1970s and 1980s, its predicted effects have been swamped by other developments, such as oil prices and the dollar’s exchange rate, that largely determined our inflation performance. But with the economy’s expansion steadily reducing unemployment to levels not achieved since the late 1970s, Phillips curve effects have become the most recent concern of inflation watchers.
Most economists see the relation between unemployment and inflation as operating through wages. In tight labor markets, wages rise faster as employers compete for increasingly scarce labor.
With productivity increases unable to keep up with rising hourly wages, firms’ labor costs per unit of output rise and force prices to rise in pace. Because the first step in this process is the tightness of the labor market, we should first look at just how tight that market is today.
The composition of the labor market changed a great deal during the past two decades. One prominent change came about with the increasing and increasingly permanent participation of women in jobs outside the home.
Because many women used to have less permanent job attachments than men, experiencing frequent spells of unemployment as they reentered the work force or changed jobs, the unemployment rate for adult women was chronically higher than the rate for adult men. As more adult women entered the work force in the 1970s, their higher unemployment rates raised the total unemployment rate that corresponded to a tight overall labor market.
An even more pronounced effect came from the influx of young workers into the labor market. Because teen-agers have very little job attachment, changing jobs frequently or leaving and reentering the work force because of school, they experience frequent spells of transitional unemployment and, as a group, have much higher unemployment rates than adult workers. As the number of young workers swelled in the 1970s, so did the total unemployment rate.
The result of these trends in the proportion of women and teen-agers in the work force raised the attainable aggregate unemployment rate substantially by the end of the 1970s. At that time, some economists estimated that full employment for the economy as a whole corresponded to an aggregate unemployment rate of 6% or even 7% compared with perhaps 4.5% in the mid-1960s. And as the economy approached these unemployment levels, many feared the onset of inflationary pressures originating in tight labor markets.
What many observers have failed to notice is that the demographic changes have recently moved in the other direction.
The baby boomers have become adults with steady job attachments, and women’s unemployment rates have become as low as men’s even in tight labor markets.
Thus, compared with a decade ago, lower total unemployment rates can now be achieved before labor markets generate inflationary pressure--that is, before they become “too tight.”
The table below compares recent unemployment rates for different demographic groups with those rates in 1963. I choose 1963 because it was widely considered to be a year when unemployment was too high and when policy aimed for, and got, several quarters of non-inflationary economic expansion that reduced overall unemployment much further.
The state of the labor market then and now looks remarkably similar. This suggests that we are still some distance from a market that is too tight and that threatens serious inflationary pressures originating in wages.
However, tightness is a matter of degree and wages are likely to rise somewhat faster this year than last, when wages did not even keep up with the CPI and profit margins widened in many industries. This year, firms should be able to absorb some speed-up in wage increases without a corresponding speed-up in the rate at which their prices rise.
On balance, then, we are still in the middle ground where inflationary pressures exist but are not alarming. Objective analysis indicates that the economy should be allowed to continue expanding at a rate that will gradually reduce unemployment further. This would not only benefit the unemployed but also raise profits, stimulate investment and provide much-needed government revenues.
Does this objective assessment of the labor market lead directly to a forecast of what policymakers will actually do?
Not quite. The Federal Reserve is particularly concerned about inflation and, in an uncertain world, will probably choose to take its risks on the side of being too tight rather than too easy. So even though the economy cannot reasonably be described as overheated, today’s relatively low unemployment rates are already nudging interest rates up.
Unemployment Rates by Age and Sex
1963 1988 Males, 16-19 17.3% 16.6% Males, 20+ 4.5 5.0 Females, 16-19 17.1 15.3 Females, 20+ 5.4 5.0 Total Civilian Rate 5.7 5.7
