The Question of Full Employment

by: Cliff Waldman, Chief Economist

In May, the U.S. unemployment rate fell to a remarkably low 4.3%, the lowest level since May of 2001. In the past, few would have doubted that this was either at or close to full employment, the level below which wage and inflation pressures begin to create growth-killing instabilities. Currently, however, there is reason for debate, and it’s an argument with significant consequences. If the U.S. labor market has truly reached full employment, then labor shortages, wage pressures, and inflation concerns should be just around the corner. The Federal Reserve, at least in theory, should respond by accelerating its normalization of monetary policy from the extraordinary accommodation of the post-Great Recession period.

Simple thinking has often failed in the past decade. Broader consideration is needed to fully understand the current U.S. labor market picture. Alongside the lowest unemployment rate in 16 years, the U.S. has the lowest labor force participation rate since the late 1970s. Labor market tightness is met with a constrained labor force the likes of which many have never seen before. How can we talk about “full employment” when labor supply has been such an oddity?

Such ambiguity must be considered in thinking about the May jobs data, which revealed a measurable but not alarming weakening in the employment picture. Total nonfarm payroll growth slowed to 138,000 in May, modestly weaker than the 168,000 average of the first four months of 2017. After five months of gains, manufacturing jobs were essentially flat. The job losses in the retail sector continued, the consequence of a rout in the lower and middle price department stores that has been a long time coming as internet shopping gains ground with middle income consumers. Many commentators are suggesting that a tight, fully-employed labor market is the driving force behind the overall slowdown in job gains. But with a very low labor force participation rate falling even further, the better explanation is that job gains are simply slowing amidst the disappointing U.S. economic sluggishness that has characterized the early months of 2017.

The question of full employment is the key one for the coming months.  Manufacturers, who are finally feeling some benefit from a brighter global economic picture, would do well to follow this critical juncture in the U.S. labor market.