The Economy That Wasn’t Supposed to Happen: Booming Jobs, Low Inflation

The labor market the United States is experiencing right now wasn’t supposed to be possible.

Not that long ago, the overwhelming consensus among economists would have been that you couldn’t have a 3.6 percent unemployment rate without also seeing the rate of job creation slowing (where are new workers going to come from with so few out of work, after all?) and having an inflation surge (a worker shortage should mean employers bidding up wages, right?).

And yet that is what has happened, with the April employment numbers putting an exclamation point on the trend. The jobless rate receded to its lowest level in five decades. Employers also added 263,000 jobs; the job creation estimates of previous months were revised up; and average hourly earnings continued to rise at a steady rate — up 3.2 percent over the last year.

Compare that reality with the projections the Federal Reserve published just three years ago. In mid-2016, Fed officials thought that the long-run rate of unemployment would be around 4.8 percent, and that this would coincide with 2 percent inflation.

If that were the jobless rate today, 1.9 million Americans would not be working who are instead gainfully employed. And despite this ultralow unemployment rate, inflation is only 1.6 percent over the last year, below the level the Fed aims for.

Because this is 2019 and everything immediately devolves into partisan warfare, these good results are immediately seized upon by Trump partisans who view the good news as a result of the president’s policies, and by opponents who give credit to the already-improving economy that President Obama handed over in January 2017.

There is truth in both. The job market had already been improving for years when President Trump took office, and its performance since then has been more continuation of the trend than an abrupt upturn.

After more than two years of the Trump administration, warnings that trade wars and erratic management style would throw the economy off course have proved wrong so far, and tax cuts and deregulation are most likely part of the reason for the strong growth rates in 2018 and the beginning of 2019 (though most forecasts envision a slowing in the coming quarters as the impact of tax cuts fades).

In particular, it now appears that recession fears that emerged at the end of 2018 were misguided — especially once the Fed backed off its campaign of rate increases at the start of 2019.

But beyond the assigning of credit or blame, there’s a bigger lesson in the job market’s remarkably strong performance: about the limits of knowledge when it comes to something as complex as the $20 trillion U.S. economy.

The last few years have made it clear that the Phillips curve — the relationship between unemployment and inflation — has either changed shape or become irrelevant.

The breakdown of the old guidelines suggests that policymakers need to avoid overreliance on them, and to stay broad-minded to the full range of economic possibilities. Maybe using data from a few decades in the middle of the 20th century to set policy in the 21st isn’t actually a good idea.

The results of the last few years make you wonder whether we’ve been too pessimistic about just how hot the United States economy can run without inflation or other negative effects.

There are even early signs that the tight labor market may be contributing to, or at least coinciding with, a surge in worker productivity, which if sustained would fuel higher wages and living standards over time. That further supports the case for the Fed and other policymakers to let the expansion rip rather than trying to hold it back.

It’s tough setting economic policy. To make decisions, you have to create a forecast, and there’s a reason these forecasts tend to be based on historical experience.

But the last 20 years have been a wrenching period for the world economy, with all sorts of forces that have reshaped fundamentals: globalization, demographic shifts, technological changes and much more.

The continued boom in the American job market suggests that economic policymakers need to be open-minded about when the old relationships and rules of thumb no longer apply.

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