When it comes to the US labor market, it’s a tale of two extremes according to a recent report by Goldman Sachs.
At one end, the rate of short-term unemployment, defined as those unemployed fewer than 15 weeks, is lower than at any point since the Korean War and is already 0.4% below the bottom reached in the late 90s boom, with half of the gap likely due to demographic change. According to Goldman economists, “from the perspective of workers transitioning briefly between jobs whose attachment to employment is high, this is already a very tight labor market.”
At the other end, the pool of struggling workers at the margins of the labor market remains larger than in past expansions. In particular, the rate of medium- to long-term unemployment, defined as those unemployed at least 15 weeks, remains 0.75% higher than the low reached in the late 90s boom, and almost none of that gap is attributable to demographic change.
The delta between the two labor markets is shown in the chart below.
Without going to much into the reasons behind this divergence here (we will cover them in a subsequent post), the current state of the labor market presents a difficult trade-off for monetary policymakers, Goldman claims. On one hand, the pool of struggling workers on the margins of the labor force is still noticeably higher than in past expansions, and the possibility of bringing some of them back into employment is not an entirely lost cause. Quantified, this would represent a potential influx of millions of potential workers who have mostly fallen out of labor force for one reason or another. Their return could be catalyzed by a hotter labor market which would likely raise their probability of re-employment a bit further.
The decline in the share of prime-age individuals who report being discouraged, disabled, or uninterested in working has boosted the overall participation rate by 0.5pp over the last two years. A very hot job market could plausibly provide a boost of another few tenths in coming years, though it is less clear whether this boost would prove sustainable beyond the current cycle. This would cause the participation rate to fall more slowly than implied by population aging effects (as our standing forecast already anticipates) rather than to rise outright, and it means that for a given level of job creation, the unemployment rate would fall about 0.5pp less than without the participation boost.
Goldman then makes this fascinating observations: the consequence of letting the labor market tighten further is that the short-term unemployment rate, already at levels never seen outside of major wartime mobilizations, will fall further still.
As Exhibit 2 makes clear, the short-term unemployment rate is unlikely to simply move sideways while the long-term rate catches up. Why does this matter? One reason is that because of their greater attachment to employment, the short-term unemployed probably do matter more for overall labor market tightness. While popular predictions several years ago that wage growth would accelerate sharply because of the low short-term unemployment rate have not fared well, an exceptionally low rate of short-term unemployment probably does heighten the risk of overheating eventually.
What are the monetary implications?
This trade-off offered by a high-pressure economy did not appeal to Fed officials last year, and despite the still-restrained rates of wage growth and inflation, we doubt that they find it much more appealing today. We expect that preventing the labor market from moving into almost unprecedented territory will continue to provide a very strong motivation for a steady pace of tightening in coming years.
In other words, in its ongoing attempt to reflate, the Fed has recreated a functional war economy – at least in terms of labor metrics – and if only for the subsegment of the labor force that is not disabled, discouraged or doesn’t want a job (or is on drugs). For everyone else, this remains a recession. The good news, according to Goldman, is that the Fed won’t push even more…. unless Goldman is wrong of course, in which case those millions who remain locked out of a job will become increasingly frustrated, disenchanted, and more vocal, at which point their only possible means to re-enter the labor market would be with a non-hypothetical, and all too real war, to take “advantage” of the millions of low-skilled, rusty and/or otherwise “damaged” former-workers whom nobody would hire otherwise.
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