Keeping the search alive

The US economy added 313,000 jobs in February and the unemployment rate remained unchanged at 4.1%. The construction industry increased payrolls by 61,000 – the biggest gain since 2007 – while retail added some 50,000 jobs.

However, average hourly earnings rose just 4 cents in February to $26.75, a 2.6% year-on-year increase. That was lower than the 2.8% rise recorded for January.

The latest blowout US jobs report will keep the Federal Reserve hunting for wage growth. It’s likely to keep the central bank searching for the elusive Phillips curve and why pay growth remains tepid.

The Phillips curve posits an inverse relationship between unemployment and inflation. A tighter labour market should mean that companies compete to attract scarce workers by bidding up wages – and wage growth accelerates as unemployment reaches new lows. Higher pay feeds into inflation.

In recent years, though, prominent global economists have questioned whether the curve is “flattening,” meaning wages are becoming less sensitive to unemployment. Recent factors such as the decline of unions, a rise in automation and deepened globalisation might reduce the bargaining power of workers.

Traditional measurements seem to support that view. The unemployment rate has dipped from 5% in late 2015 to just over 4% now, passing beneath the Fed’s most recent estimate of the long-run normal rate of unemployment. Yet year-on-year growth in average hourly earnings has hovered at around 2.5% during that time – only a bit higher than inflation. By contrast, wage growth ran at more than 3% in mid-2007, just before the last recession.

Some economists point to more expansive measures of joblessness, however. Many workers dropped out of the labour force, and traditional unemployment statistics, during the recession. Some are now re-entering the labour market, explaining why the unemployment rate has remained flat since October, despite job gains. They may now be holding down wages.

Moody’s Analytics, has looked at the relationship between non-employed people aged 25 to 54, which includes people who have given up looking for work, and employment costs for wages. Recent data more or less fit the historical trend.

The minutes of the most recent Federal Open Market Committee meeting, held January 30-31, say that “almost all” participants in a discussion agreed that the Phillips curve remains a useful framework for thinking about employment and prices. But it’s not an especially satisfactory one: the FOMC reviewed a number of alternative models, all of which were found wanting.

The February jobs report is likely to keep that search alive.

Alan McQuaid (12/3/18)