How Full Employment Turned Washington’s Creed


As President-elect Joseph R. Biden Jr. prepares to take office this week, his administration and the Federal Reserve point out a unique economic goal: to get the labor market back to where it was before the pandemic.

The buzzing work environment that existed eleven months ago – with 3.5 percent unemployment, stable or rising labor force participation, and steadily rising wages – proved to be a recipe for raising all boats, creating economic opportunities for long-disenfranchised groups and reducing poverty rates. And the price gains remained manageable and even a little low. This contrasts with efforts to push the boundaries of the labor market in the 1960s, widely blamed for laying the foundations for runaway inflation.

Then the pandemic shortened the test run, and efforts to contain the virus resulted in unemployment rising to levels not seen since the Great Depression. The recovery has since been interrupted by additional waves of contagion, withdrawing millions of workers and recurring job losses.

Policy makers across government agree that a return to this hot labor market should be a key objective, a remarkable shift from recent economic expansion and one that could help shape the economic recovery.

Mr Biden has made it clear that his administration will be focused on workers and has selected top officials with a focus on the labor market. He has selected Janet L. Yellen, a labor economist and former Fed chair, as his Treasury Secretary and Marty Walsh, a former union leader, as his labor secretary.

In the past, lawmakers and Fed officials have tended to preach allegiance to full employment – the lowest unemployment rate an economy can sustain without fueling high inflation or other instabilities – while withdrawing fiscal and monetary support before they did achieved this goal because they feared that they would be more patient approach would cause price spikes and other problems.

That shyness seems less likely to raise its head this time.

Mr Biden will take office as the Democrats control the House and Senate, and at a time when many politicians are less concerned about the government taking on debt due to historically low borrowing costs. And the Fed, which has been shown to raise interest rates when unemployment falls and Congress spends more than taxes, has pledged to be more patient this time around.

“Economic research confirms that in conditions like today’s crisis, especially with such low interest rates, immediate action – including deficit financing – will help the economy in the long term and in the short term,” Biden said at a January 8 press conference that highlighted that acting quickly would “reduce scars on the workforce”.

Jerome H. Powell, chairman of the Fed, said Thursday that his institution is focusing heavily on restoring the lowest unemployment rates.

“This is really what we focus on the most – getting back to a strong job market fast enough that people’s lives can get back to where they want to be,” said Powell. “We were in a good place in February 2020 and we think we can get back there much sooner than we feared.”

The conditions are in place for a macroeconomic experiment to see if large government spending packages and growth-friendly central bank policies can work together to promote a rapid recovery that spans a wide range of Americans without causing harmful side effects.

“The thing about the Fed is that it really is the tide that raises all boats,” said Nela Richardson, chief economist at ADP, that the work-oriented central bank can lay the foundation for robust growth. “Fiscal policy can appeal to certain communities in ways that the Fed cannot.”

The government has willingly spent to prop up the economy in the face of the pandemic and analysts expect more help is on the way. The Biden government has proposed an ambitious spending package of $ 1.9 trillion.

While this is unlikely to happen in full, at least some more household spending seems likely. Goldman Sachs economists believe that Congress will actually pass another $ 1.1 trillion in relief in the first quarter of 2021. This complements the $ 2 trillion pandemic aid package passed in March and $ 900 billion in additional aid in December.

This would contribute to a faster recovery this year. Goldman economists estimate the spending could help bring the unemployment rate down to 4.5 percent by the end of 2021. Unemployment stood at 6.7 percent in December, the Bureau of Labor Statistics said earlier this month.

Such a government-sponsored recovery would be in stark contrast to what happened during the 2007-2009 recession. Back then, the largest package in Congress to counter the effects of the downturn was the US $ 800 billion Reconstruction and Reinvestment Act, passed in 2009. It was exhausted long before the unemployment rate finally fell below 5 percent in early 2016.

At the time, deficit concerns helped contain more aggressive fiscal responses. And concerns about economic overheating led the Fed to raise interest rates, albeit very slowly, in late 2015. As the unemployment rate fell, central bankers feared that wage and price inflation might wait around the corner and were keen to bring policies back up to a “normal” setting.

But economic thinking has changed fundamentally since then. Tax authorities have become more confident about boosting public debt at a time when interest rates are very low, when it is not so costly.

Fed officials are much more modest now about whether or not the economy has “full employment”. After the 2008 crisis, they believed that unemployment was testing its healthy limits, but unemployment continued to decline sharply without price hikes spiraling out of control.

In August 2020, Powell said he and his colleagues will now focus on “deficits” in full employment rather than “deviations”. Unless inflation actually picks up or the financial risks are great, falling unemployment is seen as a welcome development and not a risk to be averted.

That means interest rates are likely to stay near zero for years. Senior Fed officials have also signaled that they expect to continue buying huge sums of government bonds, around $ 120 billion a month, over the coming months.

Fed support could help boost government spending to boost demand. Households are expected to amass large reserves of savings when they receive economic reviews in early 2021 and then deplete them as vaccines spread and normal economic life resumes. Low interest rates could make large investments – like houses – more attractive.

However, some analysts warn that today’s policies could lead to problems in the future, such as: B. Inflation spiraling out of control, taking financial market risk or a harmful debt overhang.

In the mid to late 1960s, Fed officials focused heavily on the hunt for full employment. When testing how far they could push the labor market, they made no attempt to stave off inflation as it crept in and saw higher prices as a compromise for lower unemployment. When America broke its final steps from the gold standard in the early 1970s and an oil price shock struck, price gains spiked – and it took a massive Fed tightening of the money belt and years of serious economic pain to tame.

There are reasons to believe that this time is different. Inflation has been low for decades and remains limited worldwide. The relationship between unemployment and wages and wages and prices was weaker than in previous decades. From Japan to Europe, the problem of the era is weak price gains that keep economies stuck in cycles of stagnation by undermining the scope for rate cuts in tough times rather than excessively rapid inflation.

And economists are increasingly saying that while costs can arise from long periods of growth-friendly fiscal and monetary policy, there are also costs from being too cautious. If labor market expansion is slowed down earlier than necessary, workers who would have received a boost from a strong labor market can stand on the sidelines.

The pre-pandemic era has shown what overly cautious policies are at risk of lacking. By 2020, black and Hispanic unemployment had fallen to record lows. The participation of prime-age workers who were expected to remain depressed on a persistent basis had actually increased somewhat. Wages rose the fastest for the low-paid.

It’s not clear if 3.5 percent unemployment will be exactly the level America will return to. What is clear is that many policymakers want to test what the economy is capable of rather than guessing a magic number beforehand.

“There is a danger of taking a number and saying we’re there,” said Mary C. Daly, president of the Federal Reserve Bank of San Francisco, at an event earlier this month. “We’re going to learn these things experimentally, and that’s the right risk management attitude for me.”