What's at stake with restoring 'balance' to the labor market?

Yesterday was Fed Day, and tomorrow is Jobs Day. Fighting inflation and fighting for paychecks. It's important to remember what we lose if we lose jobs.

On jobs, here’s Fed Chair Jay Powell at the press conference:

Although the pace of job gains has slowed over the course of the past year and nominal wage growth has shown some signs of easing, the labor market continues to be out of balance. Labor demand substantially exceeds the supply of available workers, and the labor force participation rate has changed little from a year ago.

And that “imbalance” was central to the Fed’s decision to raise the federal funds rate to 4.5%. And its commitment to “do more.” It’s also an imbalance in favor of workers that the economy refuses to let go of, at least for now. Today’s example: initial jobless claims remain exceptionally low, despite high-profile layoffs in some sectors.

Lisa Abramowicz @lisaabramowicz1

Initial jobless claims fell to the lowest since April 2022 last week. Where's the labor market weakness that everyone talks about?

There is a logic to the Fed’s view that reducing the demand for labor is necessary to bring inflation down. And even if reality hasn’t lined up so neatly, they are likely correct. And high inflation during the past few years has diminished the economic well-being of families. An inability to get inflation would come with long-term costs. But so do smaller wage increases, fewer job opportunities, and higher unemployment.

Today’s post is not to argue with the Fed. Instead, I attempt to bring research perspectives on the current and future costs of higher unemployment.

The higher unemployment, the more damaging job loss is.

I [Chair Powell] think most forecasters would say that unemployment will probably rise a bit from here. But I still think -- I continue to think that there's a path to getting inflation back down to 2 percent without a really significant economic decline or a significant increase in unemployment. And that's because the -- you know, the setting we're in is quite different.

The difference between “a bit” and “significantly” would mean the world to workers. There is a path forward that preserves the gains of the job-full recovery, and it’s important to understand the costs if we fail.

For over a year, there’s been a contentious debate about how high unemployment must go to bring the high inflation down. Encouragingly, inflation has started to decrease recently, while unemployment remains at a fifty-year low and wage growth is solid. But with the slowing growth of consumer spending and a contraction in business investment, unemployment will almost certainly increase this year. The degree to which matters.

Studying mass layoffs from 1982 to 2005, Steven Davis and Till von Wachter found that the higher the unemployment rate is when someone loses their job—recession or not—the larger the earnings losses are. That’s true in the initial years:

And it’s true over the longer term as well:

In present-value terms, men lose an average of 1.4 years of predisplacement earnings if displaced in mass-layoff events that occur when the national unemployment rate is below 6 percent. They lose a staggering 2.8 years of predisplacement earnings if displaced when the unemployment rate exceeds 8 percent.

So, avoiding a significant rise in unemployment is essential. Likewise, getting unemployment down as quickly as possible after a recession matters. With our current job-full recovery, the unemployment rate fell back to 6% in March 2021, but not until September 2014 in the jobless recovery after the Great Recession.

The effects of job losses are long-lasting.

While financial markets react within seconds to the FOMC statement and Powell’s words, the effects on unemployed workers last for years. Ariel Gelrud Shiro and Kristin Butcher found annual earnings loss that persisted for a decade.

Their findings are consistent with decades of research using various data sources and study designs. Unemployment is harmful to workers when it happens, and the damage lasts.

Unemployment affects some groups more than others.

According to the NBER’s official definition, a recession is “a significant decline in economic activity spread across the economy that lasts more than a few months.” It’s important to note that “spread across” is not the same as spread evenly. Studying 1979 to 2011, Hilary Hoynes, Douglas Miller, and Jessamyn Schaller found that a one percentage point increase in the unemployment rate (using variation in groups across states) was not experienced uniformly. For example, unemployment was two percentage points higher for those with less than a high school degree but only 0.5 percentage point higher for college graduates.

The Covid recession underscored that the cause of the recession and which industries are hit the hardest matter for which groups are affected most. Unlike prior recessions, the service industry was hit hardest during Covid, and thus women’s, not men’s, unemployment (unlike in the research above) rose more.

In closing

The dual mandate is a hard one. As critical as I am on here, and maybe sometimes unfairly, I am not saying anything the Fed does not know.

Yes, there are costs from high inflation. And there are costs from high unemployment. We must talk about both and who bears them. The research on unemployment reinforces what we have to lose if a recession comes this year. And what we avoided by having a job-full recovery.