THE ECONOMY: HOW STRONG? : Jobs-Inflation Link by Fed Called Flawed : Policy: Critics say government, Wall Street use outdated figures to determine ‘full’ employment threshold.
With nearly 14 million Americans out of work, marooned in part-time jobs or too disheartened to answer a help-wanted ad, could the United States be approaching “full” employment?
Key Federal Reserve officials, along with many on Wall Street, believe that--as a practical matter--the answer is yes: that the economy has entered a danger zone where further jobs growth could set off an upward spiral of inflation.
That belief, which has helped justify four interest rate hikes this year and may hasten the next one, has sparked a controversy that goes to the very core of the U.S. economy’s capabilities in a world of changing technology and global business links.
“How would an average person in California respond to the notion that somehow we’re growing too fast and have to slow the economy down?” asks Lawrence Mishel, research director at the Economic Policy Institute, a liberal think tank.
Critics say the Fed is relying on an outdated world view that has failed to consider sweeping changes that are likely to keep the lid on inflation as joblessness shrinks further.
Moreover, the jobs-versus-prices flap comes at a time when the labor market, despite significant gains, still has pockets of distress.
While the national unemployment rate in April was pegged at 6.4%, that is just an average figure. The experience of regions, racial groups and industries differs drastically.
In California, almost 1.5 million people are looking for work, and the unemployment rate is 9.6%, according to state data. By contrast, the rate in North Carolina is 3.9%.
Nationally, the rate of unemployment among whites is 5.6%, according to the Bureau of Labor Statistics. But the black unemployment rate is 11.8%, and the Latino rate is 10.8%.
One in three Americans still believes that jobs are “hard to get,” the Conference Board reported Tuesday, a slight increase from April.
Given the disparities of fortune, the question of when to slow the economy through interest rate hikes takes on huge personal and political ramifications.
“You’d hate to throw away 500,000 jobs that it might not be necessary to throw away,” observed Laurence H. Meyer, an economic forecaster in St. Louis.
Nonetheless, what Fed officials abhor most is the prospect of inflation, which could unhinge the financial markets and undermine the entire recovery.
They have lately become concerned that the economy is running out of “slack”--unused factory capacity and available workers. The jobless rate has been on a downward trend for almost two years, dipping to 6.4% in April from 6.7% in January.
Factories, meanwhile, have been humming, another sign that the economy continues to push forward at high speed: Operating rates have churned up to 83%, closing in on the traditional inflation threshold of about 85%.
As the economy runs out of slack, goes the view, shortages of labor and materials lead to inflation. And inflation erodes the value of bonds.
“What’s important is that the country has removed an awful lot of slack in the economy,” said Robert Parry, president of the Federal Reserve Bank of San Francisco, in an interview.
Parry doubts that anyone can pinpoint the precise unemployment rate that triggers inflation, but he suggested it lurks somewhere between 6% and 6.5%, and probably “in the higher part of that range.”
*
Therein lies the dispute.
Critics say the Fed is counting too heavily on theories hatched in an entirely different era. Nowadays, they contend in a theory of their own, a range of new, anti-inflationary forces have transformed basic economic behavior.
“There is no question that this (unemployment) is what the Fed has been focusing on, and there is no question there are faults in their methodology,” said Mickey D. Levy, chief financial economist with NationsBank in New York.
Corporate cost cutting, for example, has evolved from a fad to a new business culture, with major implications for keeping the lid on prices.
Consider hiring practices: By some estimates, one in five jobs generated during the recovery has been temporary, saving employers much of the expense of permanent staffers who qualify for full benefits.
Global forces are also at play. More than ever, foreign workers and factories are ready to meet the needs of U.S. consumers when America approaches the limits of its own industrial capacity.
“They’re just wrong,” Robert Pollin, an economics professor at UC Riverside, said of the Fed’s worries that America’s falling unemployment rate threatens an inflationary spiral. “They haven’t factored in the downward wage pressures from global competition.”
The pressures take various forms. Robert M. Solow, a Nobel laureate economist at the Massachusetts Institute of Technology, believes that American workers are “excruciatingly aware” their jobs can be shifted overseas and, therefore, they are reluctant to push for pay hikes than they used to be.
These days, if Ford and Chrysler cannot sell cars fast enough to meet demand, prices need not shoot up--because Toyota or Nissan is happy to oblige.
The same principle may apply to the labor market in a world flooded with employees ready to offer their services at wages far lower than U.S. levels.
“If some of the world’s best physicists can be hired in Russia for $100 per month, why should anyone pay a third-rate American physicist $50,000 a year?” MIT economist Lester C. Thurow recently asked in the New York Times.
Once upon a time, a national policy of full employment meant what it sounded like: The goal was a job for everybody who wanted one.
But it soon became clear that stubborn realities block the path to so idyllic a state. Employers’ needs don’t always dovetail with applicants’ skills. Qualified employees may not know about job openings, and even if they do, the workplace may be far away.
On top of that, a certain number of workers always are quitting or getting fired.
*
By the 1960s, economists counseled that an unemployment rate in the 4% range was the flash point for inflation.
Then came the youthful baby boomers, largely unsettled in life, inexperienced in the workplace and often lacking job skills. Estimates of the inflationary flash point floated toward a 7% unemployment rate.
Fast-forward to 1994, and the picture has changed once more.
Economists believe the danger zone has gotten lower, partly due to a more experienced work force, and peg it in a range between 5% and 6.5%.
But that range covers a lot of territory: The difference of 1 1/2 percentage points could be the difference of up to 2 million jobs, said Ross DeVol, an economist with the WEFA Group in suburban Philadelphia.
The debate over the correct level “is fundamentally important,” he says. “The Fed is going to be under increasing political attack if it continues to tighten and there is no sign of inflation. Congress is going to be livid.”
Just last week, Democratic lawmakers assailed the Fed for precisely that. At a Senate hearing, Sen. Paul S. Sarbanes (D-Md.) held up an editorial cartoon depicting Fed Chairman Alan Greenspan with a sign proclaiming, “The economy is picking up. We are doomed.”
The issue could become even touchier in the coming weeks, in light of some new signs that the economy is perking along faster than expected. The Commerce Department recently surprised analysts by revising upward to 3% the nation’s growth rate for the first three months of the year.
In any case, this much is agreed upon: A recovery once dubbed “jobless” is spewing out new jobs by the hundreds of thousands, and it is doing so without sparking wage inflation so far.
But the Fed is on a course of raising interest rates anyway, a strategy that will reduce jobs growth in the future: “To the average person on the street, I’d guess this doesn’t make a lot of sense,” DeVol said.
