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Unemployment's Steady Fall Could Signal Trouble -- or a Broader Structural Shift -- The Outlook

27 Aug 2017 8:02 pm
By David Harrison 

The unemployment rate has fallen to a 16-year low of 4.3% and may not be done falling.

The question is whether that is good news because it means the economy is still operating below capacity and has plenty of room to run, or bad news because it means the economy is close to overheating and heading for trouble.

A study by the Federal Reserve Bank of San Francisco finds that over the past century, the jobless rate's "natural" level -- meaning the level that signals an evenly balanced economic expansion -- has fluctuated in a relatively narrow band between 4.5% and 5.5%. If it goes much above that range it means recession, and much below it could signal inflation or other economic excesses building. It's now been below that level for four straight months, without obvious evidence of overheating.

Structural changes in the economy could alter this theoretical natural rate, meaning the jobless rate might have room to go lower without throwing the economy off balance. One reason is the aging workforce. Jobless rates tend to be lower for older workers, who are better trained than younger workers and tend to be more settled in their jobs. With a large portion of the workforce in older age groups, it might be the case that the economy can handle a lower jobless rate.

In 2015, economists at the Chicago Fed estimated that the aging workforce could have pushed the natural rate considerably below both Fed officials' estimates and those calculated by the Congressional Budget Office. One of their estimates predicted the natural rate could fall to as low as 4.1% by the fourth quarter of 2017, below where the actual rate stands now.

Other factors could be at play. Globalization might help drive unemployment down at home without affecting broader inflation trends. U.S. workers now compete with workers from around the world. An abundance of low-wage workers in China and other developing economies could hold down wages and prices in the U.S. in ways that didn't happen a decade or two ago. Likewise, technology could be reshaping the interplay of unemployment and inflation: Amazon.com Inc., the internet retailing giant that uses advanced robotics to manage sophisticated warehouse planning, plans major price cuts at Whole Foods Markets Inc., which it recently purchased.

"Digital technology was finding its way on the factory work floor and offices in a big, big way in a very positive, broad fashion," Charles Evans, president of the Federal Reserve Bank of Chicago, said in an interview. "It makes you wonder if competition is beginning to take place along lines that haven't been contemplated. Competition in many forms would adjust price margins."

This is a hot topic at the Federal Reserve because inflation isn't behaving the way officials expect it to behave with such a low jobless rate. In the past 12 months, the jobless rate has dropped from 4.9% to 4.3%. That decline suggests inflation should be picking up. Instead, a measure of underlying inflation -- the personal consumption expenditure price index excluding food and energy -- has dropped over that period from 1.7% to 1.5%.

When the jobless rate is higher than the natural rate, Fed officials tend to keep borrowing costs low to drive down unemployment. But when the jobless rate drops below the natural rate, it might signal inflation -- and officials push up interest rates. The current low rate underpins the Fed's plan to keep raising rates. But the fact that inflation is so low is making some officials wonder if they can afford to let the jobless rate continue to drop and slow the pace of rate increases. The Fed has raised interest rates four times since 2015 and penciled in another rate increase this year and three more next year.

Robert Kaplan, president of the Federal Reserve Bank of Dallas, said the natural rate is probably lower than it has historically been and the wage and price pressures typically associated with low unemployment are muted due to technological change and globalization. He sees the jobless rate continuing to fall.

"We're living an experiment now [where] the unemployment rate is falling and it's fallen below the point that people where would have predicted an inflation pickup," said Laurence Ball, a Johns Hopkins University economist. "You can imagine the experiment continuing: unemployment going even lower and inflation still not picking up."

In Mr. Ball's view, the natural unemployment rate and the actual unemployment rate feed on each other so that a lower unemployment rate pushes down the natural rate, which in turn pushes down further on the unemployment rate.

"It could be that unemployment drops down to 3-something [percent] and stays there and inflation stays low," he said.

That might be the case, but history offers some warnings. The jobless rate bottomed out at 3.8% in April 2000. It spent nine months at 3.4% in 1968 and 1969. But in both cases, recessions weren't far behind, one driven by a technology bubble in the 1990s and rising inflation in the 1970s.

--Ben Leubsdorf contributed to this article.

Write to David Harrison at david.harrison@wsj.com
 

(END) Dow Jones Newswires

August 27, 2017 16:02 ET (20:02 GMT)

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