Why lower unemployment doesn’t mean higher inflation
The September employment report from the Bureau of Labor Statistics — with 248,000 jobs created, and unemployment declining to 5.9 percent — heightened speculation that the Federal Reserve will begin raising interest rates in early 2015, rather than waiting until later in the year.
That is in part because many Fed-watchers anticipate that Fed governors will begin to see signs of accelerating wage and price inflation, as unemployment continues to fall toward the level economists call the ‘natural rate of unemployment,’ or in technical terms, the ‘non-accelerating inflation rate of unemployment’ (NAIRU). Right now, the Congressional Budget Office has pegged that level at 5.7 percent, according to Capital Economics.
That rate of unemployment is generally considered the level below which wage pressures begin to build, because the labor market has tightened enough that employers have to compete for workers by outbidding each other, explains economist Michael Strain at the American Enterprise Institute.
“If there are fewer unemployed workers around, then workers are relatively more scarce, and companies have to be more competitive to attract workers,” said Strain. “And the way that they compete is by offering higher wages.”
Strain said a parallel dynamic also puts upward pressure on wages: workers who have jobs feel like they have more bargaining power with their bosses, because they know they will be more difficult and costly to replace. So they take the risk of asking for a raise, and may even be ready to jump ship and look elsewhere if they don’t get one.
Dallas Federal Reserve Bank president Richard Fisher was quoted by Reuters last month saying that “Declines in the unemployment rate below 6.1 percent exert significantly higher wage pressures than if the rate is above 6.1 percent.”
But so far, economists are hard-pressed to find any acceleration in inflation. Price pressures are muted, and average hourly wages actually fell one cent in September.
“There are currently no signs of wage inflation reemerging,” said UCLA economist Roger Farmer.
One possible reason is that there are a lot of people who have dropped out of the workforce. Labor force participation is at 62.7 percent, the lowest level since 1978. Those people aren’t counted as unemployed, but many do want jobs. Others are working part time but want full-time work, explained Douglas Holtz-Eakin at the American Action Forum.
“If, as the unemployment rate goes down, some of those people flood back in, that slack takes some of the pressure off the inflation process.”
Also, said economist Mark Kuperberg at Swarthmore College, employers could pay workers more, without raising the prices they charge for goods and services, because of productivity increases. Higher productivity has saved employers money, which they have mostly not passed on in workers’ paychecks.
“It’s like I became twice as productive, I started producing twice as much per hour, but I was only paid 50 percent more, not 100 percent more,” said Kuperberg. “I could in principle be paid that other 50 percent and there would still be no inflation pressure.”
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