There appears to be growing consensus among economists and policymakers that inflation is now the main threat to the US economy and the Federal Reserve Board needs to start ratcheting up interest rates to slow down economic activity. While these so-called inflation-hawks are quick to highlight the cost of higher prices, they rarely, if ever, mention the costs associated with the higher interest rate policy they recommend, costs that include higher unemployment and lower wages for working people.
The call for tightening monetary policy is often buttressed by claims that labor markets have now tightened to such an extent that continued expansion could set off a wage-price spiral. However, the rapid decline in the unemployment rate to historically low levels, a development often cited in support of this call for austerity, is far from the best indicator of labor market conditions. In fact, even leaving aside issues of job quality, the US employment situation, as we see below, remains problematic. In short: the US economy continues to operate in ways that fall far short of what workers need.
A turn to austerity to fight inflation is not what we need. Neither is a continuation of policies that simply continue the growth of our currently structured economy. Instead, we need new policies that can transform our economy with the aim of employing more people, working significantly shorter workweeks under conditions that are humane and fulfilling, for a living wage, producing the goods and services required to meet majority needs in socially and environmentally sustainable ways.
Weak job creation
It is important to recognize how limited the economic recovery has been in terms of job creation. The economic boost from federal stimulus spending has now largely faded and we are still some 3.6 million jobs short of pre-pandemic employment levels. If we take into account population growth the shortfall is over 5 million.
And while the unemployment rate fell to an impressively low 3.9 percent in December 2021, the labor force participation rate (which shows the percentage of the civilian noninstitutional population 16 years and older that is working or actively looking for work) tells a very different story. That rate stood at 61.9 percent In December 2021, far below its early 2000’s peak of 67.3 percent.
In other words, one reason that the unemployment rate has fallen so low is that millions of workers have dropped out of the labor force and, as a result, are no longer considered in the calculation of the unemployment rate. Raising our current labor force participation rate to that earlier peak would require an employment increase of some 13 million workers.
There are those that argue that the current labor force participation rate paints a misleadingly negative picture of the tightness of the labor market. Many point to the fact of record-high quit rates, which they say shows that many workers are “voluntarily” choosing to leave the labor market. Leaving aside the fact that many of those who quit did so because of health concerns or a lack of childcare options, the focus on quit rates alone produces a one-sided picture of current labor market dynamics.
The reality is that the great majority of workers now quitting their jobs are doing so to take other jobs. In fact, hires are currently greater than quits in all sectors of the economy. A case in point is the accommodation and food services sector, which suffered a dramatic decline in employment during the pandemic. In November 2021, accommodation and food services recorded 920,000 quits but even more hires, 1,079,000.
Another reason offered for why our current low labor force participation should not be given too much weight in policy considerations is that it is said to be heavily influenced by Baby Boomer retirements. It is certainly true that the Baby Boomer generation has a lower labor force participation rate than that of younger cohorts. But, strikingly, and in contrast to that of younger cohorts, the labor force participation rate of those over 55 has actually grown since 2000, and even more rapidly for those over 65. In other words, older workers have been moving back into, not out of, the labor force.
The labor market experience of prime-age workers
Perhaps the best way to appreciate the economy’s employment-generating inadequacies is to look at the labor market experience of prime-age workers, those between 25 and 54 years. In the early 2000s, this cohort had a labor force participation rate of 84.2. It now stands at 81.6. Some 3.3 million additional workers ages 25-54 would have to be employed to regain that earlier labor force participation rate.
It is hard to see how one could consider the US labor market tight, meaning the economy is close to full employment when millions of prime-aged workers remain outside it. And it would take a very active imagination to believe that these workers have decided not to work because of their access to a generous government-financed system of social support. The fact is that the low labor force participation rate of this prime age cohort is a powerful indicator of just how poorly the US economy is at generating acceptable employment opportunities. Policies designed to slow economic growth and, by extension increase unemployment, are clearly unwarranted.
Inflation dangers overstated
Many of the same people that point to the tightness of the labor market as a justification for their call to tighten monetary policy also overstate the dangers of inflation. The rate of inflation has indeed spiked. The year-over-year inflation rate from December 2020 to December 2021 hit 7.0 percent, the highest rate since June 1982. However, the monthly rate of inflation has begun to slow—from 0.9 percent in October, to 0.8 percent in November, and to 0.5 percent in December.
Pandemic disruptions to the supply chain are the main cause of this recent spike in prices, a problem not unique to the United States. For example, a shortage of chips has slowed the production of new cars, leading to a sharp rise in both new and used car prices. The price rise in the auto sector accounts for almost 1.5 percentage points of the inflation we have seen over the last year.
There are clear signs that the rate of inflation has peaked and will continue to head down as supply chain disruptions are (at least temporarily) overcome, and demand itself slows. In fact, the Federal Reserve forecasts that its personal consumption expenditure inflation index will rise by only 2.6 percent in 2022, sharply down from a likely 4.4 percent in 2021. The behavior of financial investors adds confidence to this forecast. Interest rates on 10-year Treasury bonds remain largely unchanged at just over 1.7 percent.
In sum, we need to continue pushing back against calls for monetary tightening, and redouble our efforts not just to maintain current fiscal and monetary policies, with their modest expansionary impact, but to demand a more aggressive set of changes in how and in whose interest our economy operates.