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Stop Fearing Full Employment

from Thomas Palley

August’s Employment Report showed the unemployment rate fell to 5.1 percent and creation of 173,000 new jobs. Predictably, the decline in the unemployment rate has triggered calls for higher interest rates from Wall Street Hawks on grounds that higher core inflation is just around the corner. That is the same call we heard when the unemployment rate was much higher, and it is the same call we heard in the past two business cycles.

Federal Reserve policymakers should ignore the Hawks and stop being afraid of tight labor markets. In a market economy, that is the way workers get a raise. There is no reason for the Fed to rock the boat and risk confiscating the raise working families have waited for so long. That is the message this Labor Day weekend.

Though the unemployment rate fell, headline job creation was actually below expectations. Moreover, private sector job creation was only 140,000, which is much weaker than recent months. 

Employment in manufacturing fell 17,000, and the fall would have been worse absent continuing strength in auto production due to the car-buying boom. In fact, there are indications manufacturing could even be on the cusp of recession.

Comprehensive measures of labor supply, which include the labor force participation rate and the U-6 broad measure of unemployment, show continued excess supply. The U-6 rate, which includes discouraged workers and those involuntarily working part-time, is 10.3 percent. That is much higher than prior to the Great Recession.

Inflation is tame; unit labor costs are down; energy prices are down; and the strong dollar has lowered import prices and is holding the lid down on prices of domestically manufactured goods.

These are not the macroeconomic conditions that warrant a rate hike, and there are other ways (e.g. margin requirements) to deal with financial speculation and asset price inflation.

The distorted nature of our economic policy conversation is evident in the attention given to inflation hawks and the tepid response of inflation doves who only argue a rate hike should be delayed because of stock market turbulence. That is hopelessly inadequate.

The real reason not to raise rates is we are likely still a long way from full employment and wages have a lot of catching up to do. If the Fed is fretful about asset price inflation and financial stability, it should tackle those problems with other policy tools.

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