December 04, 2022
I confess I am a card-carrying member of Team Transitory, and I have been wrong about the extent to which inflation would be persistent. This was largely due to subsequent rounds of Covid, China’s zero Covid policy, and the Russian invasion of Ukraine, all factors which the inflation hawks did not anticipate either. But regardless of how we got here, the question is what things look like going forward.
We saw much more job growth in the November jobs report than most analysts, including me, had expected. By any measure, 263,000 new jobs in an economy near full employment is strong growth. It is not plausible that the economy can continue to add jobs at this pace.
Furthermore, we had a 0.6 percent jump in the average hourly wage in November. Annualized, that comes to over 7.0 percent wage growth. That is clearly not consistent with the Fed’s 2.0 percent inflation target, or anything close to it. The 1.4 percent three-month increase annualizes to 5.6 percent, which is not all that much better.
Taken together, the stronger than expected job growth, coupled with the big jump in wages, seems to indicate that we have a serious problem with inflation. The consensus seems to be that the Fed may have to keep the rate hikes in overdrive.
The Decline in Hours
There is no dispute that these are bad signs from the standpoint of inflation, but there are some items pointing in the other direction in the November report that were almost completely overlooked. First, although we did see a big jump in employment in the month, the length of the average workweek actually fell by 0.1 hour. This was not just the result of rounding; the index of aggregate weekly hours fell by 0.2 percent.
Hiring new workers and increasing hours per worker are alternative mechanisms of meeting the demand for labor. When hours per worker falls, that indicates less demand for labor. When aggregate hours fall, that indicates there was actually less demand for labor in November than in October. In other words, the opposite of a strong growth. This could be a sign that employers will be looking to reduce the size of their workforce in future months.
It is important to throw out the usual qualifications. This is one month of data. The index of aggregate hours is erratic, we often see sharp shifts from month to month. It is also subject to revisions, so the picture may look different when we get the December data.
But based on what we see in the November jobs report, demand for labor actually declined in November. Also, just to be clear, there were no obvious weather events or other non-economic disruptions in the reference period that could easily explain this decline.
The Jump in Pay in Transportation and Warehousing
While the 0.6 percent increase in average hourly wages is definitely bad news from the standpoint of inflation, it was driven in large part by a 2.5 percent reported increase in average hourly wages for workers in the transportation and warehousing sector. This was apparently due to large severance payments to workers in the sector, which presumably will not be repeated.
Julia Coronado, who called this to my attention in a tweet, calculated that the increase in the average hourly wage without this jump would have been 0.45 percent in November, the same as in October. In other words, there is no evidence of acceleration, we are not seeing the dreaded wage-price spiral.
She also pointed out that the response rate for Current Employment Situation survey, which is the basis for these data, plummeted in November. That means that the revisions, which will be reported next month, could be unusually large. Of course, revisions can go in either direction, but that is again grounds for viewing the November data with more caution than usual.
Drop in Share of Unemployment Due to Quits
Many of us have long looked to share of unemployment due to voluntary quits as a good measure of the strength of the labor market. This is effectively measuring the extent to which workers are so confident of their labor market prospects that they are willing to quit one job before they have another job lined up.
This has been high throughout the year, and reached an all-time record of 15.9 percent in September. It fell back to 14.6 percent in October, and was just 13.9 percent in November. That is lower than many months in 2018 and 2019, and only slightly higher than the 2019 average of 13.6 percent.
It is also worth noting that all the duration measures of unemployment increased in November. The average duration of unemployment spells rose by 0.6 weeks to 21.4 weeks, while the median increased by 0.3 weeks to 8.4 weeks. The share of long-term unemployed (more than 26 weeks) jumped by 1.1 percentage points to 20.6 percent.
This is consistent with a weakening of the labor market where workers are finding it more difficult to get jobs. That is also what we have been seeing in the weekly unemployment insurance data, where the percentage of workers remaining on unemployment insurance has been gradually increasing for several months, even though the level is still low.
Does the November Jobs Report Mean the Fed Has to Keep Firing the Big Guns?
We should try to look at the data with as clear eyes as possible, recognizing that our priors will inevitably bias our view to some extent. The November data did not provide the optimistic picture on inflation being beaten that many of us had hoped for. However, it is not a terrible report showing the opposite either.
We need to look at all the data available. As has been widely noted, even by Chair Powell, rental inflation as measured by the CPI and PCE deflator is virtually certain to slow in 2023, as private indexes of marketed units are showing sharp drops in rental inflation and possibly even deflation. These will show up in the official measures in 2023.
We have also seen a sharp drop in shipping costs, with averages now getting close to pre-pandemic levels. After rising rapidly in 2021 and the first months of 2022, non-fuel import prices are now falling. And, the core producer price index has been showing moderate inflation for the last five months.
It is also worth noting that the upward revision to the third quarter GDP report released last week will also mean an upward revision to reported productivity growth for the quarter. It still will be fairly weak, but hugely better than the negative productivity growth figures reported for the first half of this year. With fourth quarter GDP also looking to be relatively healthy at this point, we look to be back to at least a normal productivity growth trend, which will alleviate cost pressures.
It is undoubtedly true that if wages continue to grow at a nominal rate close to 5.0 percent, we will not be able to hit the Fed’s 2.0 percent inflation target. However, given the sharp shift to profits during the pandemic, we should expect that some higher-than-normal wage gains will be accommodated by a drop in profit margins, assuming that conditions of competition have not changed from the period before the pandemic.
In short, there is still a strong case for restraint from the Fed. The November jobs report definitely points towards inflation being more of a problem than I believed before seeing it, but it is not the slam dunk that many have claimed.