Questions Abound Over Full Employment

U.S. officials would have you believe America is nearing full employment — a heady, dangerous place where wage inflation threatens to push the economy past its boiling point. But analysts are not so sure.

The disagreement is important, because it may determine how much further the Federal Reserve raises interest rates, how much more it costs consumers and businesses to pay down debt, and how quickly housing and the economy cool this year.

At their last meeting in December, Fed policy-makers added a caution to their assurance that inflation expectations were contained: "Nevertheless, possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures."

The warning was a red flag to markets: The Fed was worried that low unemployment had tightened the labor market to the point where worker shortages could push wages up, sparking a broader inflation spiral.

Analysts are sifting through data to determine how real the threat of full employment is. And every word Fed officials have since uttered has added to the debate.

In December, Richmond Fed President Jeffrey Lacker said that while the jobless rate could drift a bit lower, he didn't see a "major movement" ahead — adding that the then-5.0 percent unemployment rate was "consistent with a relatively full utilization of resources right now."

In other words, the economy was pretty much at full employment, and wage pressures were on the horizon.

But some economists say that while the job market is tighter than a year ago, it's still not inflationary.

For one thing, December's jobless rate was 4.9 percent — well above the record low 3.8 percent in April 2000.

"My own view is that full employment is closer to 4 to 4.5 percent — probably closer to the 4.5 percent range," said Diane Swonk, chief economist at Mesirow Financial.

"We're more productive than we were in the 90s and frankly we didn't start hitting wage pressures in the 90s until about a 4-3/4 percent unemployment rate," Swonk said.


Quibbling over percentage points may seem silly, but the jobless rate is just part of the equation. The participation rate is also lower than it was at the height of the last expansion, at 66.0 percent now versus 67.3 percent then.

That means more Americans are not even looking for work, either because they don't think they'll find a job or because the benefits of working don't outweigh the costs.

Northern Trust Co. economist Asha Bangalore said studies show the jobless rate would be much higher if the participation rate mimicked previous recoveries.

"In other words, the current reading of the unemployment rate partly exaggerates that implied strength in the labor market," she wrote in a research note.

Anthony Chan, chief economist at JPMorgan Private Client Services, agrees — and points to other signs of labor slack.

"When you look at the labor force participation rate and as long as you continue to see no acceleration in average hourly earnings ... I have to believe we're not at full employment yet," Chan said.

Annual growth in hourly earnings was steady at between 3.0 and 3.1 percent in the last three months of 2005, below December's 3.4 percent consumer inflation rate.

"That's showing that wage pressures are growing more slowly than price pressures, and that usually doesn't happen in an overheated labor market environment," Chan said.

But while the low participation rate is a favorite of those who believe the job market can improve further, Fed officials have argued the opposite.

Chicago Fed President Michael Moskow, who has called for further interest rate hikes, said the disappearance of some teenagers and younger women from the work force seems to be a permanent shift — due to an increased premium on education and the end of the long march of women into the workplace.

Plus, he said, aging baby boomers are putting downward pressure on the labor force, because they increase the share of the population that is retired.

"Putting all these pieces together, I do not expect a large increase in labor force participation. Accordingly, the current unemployment rate is probably close to the level associated with a healthy economy and little labor market slack," he said.

But economist Swonk believes many workers are staying home simply because the rewards are not yet enough to entice them back. In the late 1990s, she says, McDonald's offered signing bonuses and companies gave full benefits to part-time workers to keep them from quitting.

"Once you really start having bidding wars over people and you're willing to employ just about anyone who breathes, it's amazing what happens to the labor force participation rate," Swonk said.

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