May 07, 2021 | 13:25
The Fault in Our Labour Market Stars
The Fault in Our Labour Market Stars
Inflation has been a hot topic of late, but it doesn’t seem to be keeping central bankers up at night. So far, the uneven recovery of the labour market is garnering more attention from policymakers. With the U.S. adding only 266k jobs in April, that focus of concern will continue. Chair Powell has said that he thinks the expected near-term upturn in inflation, largely due to soaring commodity prices and base-year effects, will be transitory. And, with the earlier downturn causing an uneven burden on households, a return to “maximum employment” will drive the Fed’s decision to raise rates. Like the Fed, Governor Macklem has signalled that policy will remain accommodative until Canada's economy has reached a “complete recovery”. However, what exactly do central bankers mean by a full recovery?
Prior to the pandemic, we thought we had monetary policymaking (somewhat) figured out. The Bank of Canada (BoC) and the Fed would adjust policy in anticipation of the output gap closing or, put another way, when the jobless rate was consistent with its long-run “normal” level. We believed those levels were just under 4% for the U.S. and below 6% for Canada. But, with Powell now saying that the U.S. economy likely still had “room to run” when the jobless rate was 3.5%, the uncertainty bands around those benchmarks have widened. Perhaps, Powell foresaw this challenge (in part) back in his Jackson Hole speech in 2018, when he suggested “guiding policy by the stars […] has become quite challenging of late because our best assessments of the location of the stars have been changing significantly.” Hence, part of the struggle in uncovering what is meant by full employment is that we’re trying to hit a moving target.
It’s difficult to find a single “North Star” for the labour market, but we can look to a few measures that shed light on what will eventually drive policy rates higher. In the U.S., the low headline jobless rate in the last cycle overshadowed broader progress among marginalized workers (Chart 1). The gap between the overall and Black jobless rates continued to narrow after 2018, and shrank to 2.5 ppts before the pandemic. In Canada, we don’t have the historical data broken down by visible minority, but, as of April, the gap stood at 4.2 ppts. The downturn has also been harder for lower-paid and younger workers, who are overrepresented in service-sector jobs. Those inequities have not escaped the BoC and the Fed. These more inclusive measures of the labour market show that there can be a significant lag between when aggregate data are approaching “normal” levels and when an economy might be closer to its so-called maximum employment.
There are rising anecdotes of employers struggling to find workers as the economy reopens. With schools and child care not completely open and risks of COVID-19 still high among the unvaccinated, part of the labour shortages will be addressed when the pandemic eases. However, another story is that the number of potential job seekers per vacancy has been declining steadily as employers have ramped up job postings, but are struggling to hire workers (Chart 2). In the U.S., this measure was still 66% higher than its pre-COVID level in February. In Canada, although the data are not of the same quality, the story is broadly similar with roughly 50% more job seekers per posting than before the downturn. So at least for now, that supports continued easing.
In April, the BoC shifted toward a more upbeat view of the economy. If you look at measures of the labour market that partially control for some structural factors (like aging demographics), that upbeat view seems realistic (Chart 3). The prime-aged (25 to 54) employment-to-population ratio (EPR) helps control for persons who left the labour force during the pandemic, who are missed by the jobless rate. Canada’s EPR is 1.5 ppts below its pre-COVID level of 83.1%; however, adding at least 30k jobs per month would likely see it return to that level in early-to-mid-2022. That lines up almost exactly with the BoC's output gap forecast. However, if the recovery slows to a more typical pace (15k jobs per month) or immigration exceeds typical levels, then this measure of labour-market slack could persist into 2023.
In the U.S., the prime-aged EPR is still 3.5 ppts below its pre-pandemic level of 80.4%. School closures, particularly in larger cities, tended to be longer lasting than in Canada, which partially explains the difference. Looking back at the previous cycle, this measure continued to make progress after 2018 as more people found jobs. Hence, it agrees with more inclusive measures of the unemployment rate, like those broken down by visible minority. For the U.S. EPR to return to its previous level in 2022, the economy would have to add at least 300,000 jobs per month. But if it can sustain the pace of the March's gains, it could get there much faster. The risk for the U.S. recovery would be if the pace of monthly job gains slowed to a more pedestrian 150,000.
Bottom Line: Although uncertainty remains high, a material improvement in broader measures of the labour market would be consistent with our view that the BoC could start raising rates in early 2023, with the Fed following soon after. The challenge for central bankers is that monetary policy is a blunt instrument: reducing inequality in labour markets and controlling aggregate prices may not always coincide as the recovery strengthens. For now, keep an eye on where measures, such as the prime-aged EPR and job seekers per opening, are headed in the months to come for a signal of when the economy is approaching its level of “full employment”.