It's been a year since the unemployment rate pushed below five percent, reaching a level most economists would consider consistent with full employment. However, in 11 of the 12 months since the unemployment rate drop, the economy has added jobs at an above-trend pace without generating significant inflationary pressure. Businesses created 227,000 new jobs in January, nearly tripling the underlying pace of population growth; and yet, it's still unlikely that the nation’s supply of idle workers will be exhausted any time soon.
If the economy were actually at full employment, our current rate of job creation would be unsustainable. A shortage of jobless workers available to fill new jobs would cause the economy to overheat, and prices would begin climbing in an inflationary spiral. The fact that businesses can continue to add workers at an above-trend pace without sparking inflation is a sign that the economy has not yet reached its full potential and there's still room for further growth at the top of the business cycle.
You may wonder why, if the economy is creating hundreds of thousands of jobs each month, we aren't seeing rapid wage inflation as the labor market tightens. It's possible—and seems likely—that there's still considerable slack in the labor market, and the official unemployment rate doesn't accurately reflect all the nation’s jobless workers.
The 2008 recession was so severe that, at the height of the crisis, millions of workers dropped out of the workforce entirely. Those who became discouraged after a long period of joblessness and stopped looking for work were no longer counted in the official unemployment rate because they were no longer actively engaged in the labor market. Millions of additional workers were employed part time but would gladly have moved back into full-time work if given the opportunity.
As the past few years have demonstrated, these discouraged workforce dropouts and involuntary part-timers never truly left the labor market—as hiring picked back up, they returned by the millions. Broader measures of joblessness show that the labor market is still recovering from the recession’s damage. Thus, if workforce dropouts and involuntary part-time workers are counted as potential workers, the true joblessness rate could still be as high as 6.5 percent.
So, what does this hidden slack in the labor market mean for the broader economy? In all likelihood, the economy’s trajectory would be no different—the broadest measures of unemployment are falling even more rapidly than the much narrower official rate. But if the true unemployment rate is closer to 6.5 percent than the official 4.8 percent, the economy has the potential to continue growing at an above-trend pace for some time. Approximately 2.5 million workforce dropouts and involuntary part-time workers are still available to take new jobs as they become available; this population could potentially satisfy another year of demand at the present level.
If there's still untapped slack in the labor market, businesses could continue to expand without sparking destabilizing inflation. The stock market, which is always focused on future expectations, may keep rising if investors see the promise of higher corporate revenues. And the economy’s untapped workers should be able to benefit from federal stimulus-fueled growth without generating inflationary pressure.
As we continue to approach full employment, today’s positive trends will likely persist. The past year has been marked by strong job creation, rising industrial output, climbing corporate earnings and record stock valuations. Indeed, it wouldn't be surprising if today’s combination of solid growth and benign inflation sustains the boom through the long peak of the current business cycle.
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