By Howard Schneider
WASHINGTON – It took an unemployment rate nosediving below 4%, years into the last U.S. economic recovery, to raise the country’s labor force participation rate, and Federal Reserve officials are banking on a similar response in new projections that couple a renewed fight against inflation with a historic run of low joblessness.
It’s an outlook that has struck some analysts as contradictory – unemployment sitting at 3.5% for several years might be expected to raise price pressures – but it is consistent with recent research showing a long lag between rising employment and an eventual increase in labor supply and participation rates.
Fed officials expected a participation rebound would happen fast this time. So far it hasn’t.
But it appears wired into the U.S. central bank’s latest economic projections, which were released on Wednesday, and is what allows low unemployment to develop alongside falling inflation and a policy interest rate that over coming years remains below the level that would actually restrict economic activity.
It’s a scenario that seems to involve the Fed still viewing inflation as “transitory” even though that word disappeared from this week’s policy statement, and anticipating labor supply will improve and help keep prices at bay, said Vincent Reinhart, a former top Fed staffer and now the chief economist at Dreyfus & Mellon.
“Even though they no longer use the word ‘transitory,’ they believe it … This is not a policy path that brings inflation down. It is one that observes inflation coming down,” he said.
Given the low unemployment rate and projected slowdown in inflation, Reinhart said Fed officials also appear to expect “labor force participation is increasing and getting back to pre-pandemic levels,” with the additional flow of workers helping moderate wage and price increases.
On the surface, the Fed’s Dec. 14-15 policy meeting reflected a hawkish turn towards higher interest rates – it signaled three rate hikes were coming in 2022 – in a shift that could also be read as the central bank abandoning its promise of maximum employment in order to slow the economy and tame price increases currently running at twice the Fed’s 2% target.
In his post-meeting news conference on Wednesday, Fed Chair Jerome Powell bluntly acknowledged that he had been surprised by the level and persistence of inflation this year.
Fed officials planned to court higher inflation to offset years when it was below their target. The inflation they got, however, nearly closed a decade of misses in one quick jump.
LABOR FORCE PARTICIPATION
But Powell was also clear on another point: The current bout of price increases is “different” than what was expected and is being driven by dislocations still linked to the coronavirus pandemic.
Though it was proving more difficult and taking longer, those problems still should be resolved over time, he said.
One of the issues is the labor force participation rate, which fell more than three percentage points at the start of the pandemic, from 63.4% to 60.2%, before rebounding quickly through the first summer of the health crisis.
Then it stalled just below 62%, leaving the workforce still around 1.6 million people shy of the pre-pandemic peak.
Those former workers may have retired. They may be waiting on better health conditions. They may be waiting on child care.
But a study presented at the Fed’s premier research conference this year by Bart Hobijn, an economist who has worked at the New York Fed and San Francisco Fed and teaches at Arizona State University, and Aysegul Sahin, an economics professor at the University of Texas at Austin, documented that the “participation cycle” wasn’t driven by workers reentering from the sidelines of the labor market, but by those already participating choosing to stick it out through spells of unemployment and continuing to look for work.
It took much longer, Hobijn and Sahin noted, for that rising labor market attachment to be reflected in the participation rate than it did for the unemployment rate to fall. The lag, they said, could be substantial this time because of the complicating health and childcare issues.
Rising participation was one of the forces Fed officials said helped the economy during the last, decade-long recovery to reach a hoped-for state where the unemployment rate was low, wages increased, and yet inflation remained tame.
Along with their move against inflation this week, Fed officials projected the U.S. will move back to that sort of optimal state, locking into a 3.5% unemployment rate that, since the 1950s, has only been hit about 15% of the time.
“To get back to where we were, the evidence grows that it is going to take some time. And what we need is another long expansion,” Powell told reporters on Wednesday. “We’ve had a shock to labor force participation that is not unwinding as quickly as many had expected … We would all … expect that the level of maximum employment that’s consistent with price stability would increase further over time, for example, through increasing participation.”
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The Fed’s inflation “make up” https://graphics.reuters.com/USA-FED/INFLATION/zjvqkygmzvx/
The Fed’s inflation “make up” https://tmsnrt.rs/3EWunQd
Frequency of unemployment rates https://graphics.reuters.com/USA-FED/JOBS/xmpjonjjrvr/
Frequency of unemployment rates https://tmsnrt.rs/33nBSC1
Labor force (eventually) follows jobs https://graphics.reuters.com/USA-FED/JOBS/znpneeqebvl/
Labor force (eventually) follows jobs https://tmsnrt.rs/2XTgsJY
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(Reporting by Howard Schneider; Editing by Paul Simao)
