The employment report for June, to be released Friday, won't resolve considerable differences among market segments and economists concerning what lies ahead for the U.S. economy. The possibilities include a continued new normal of low and insufficiently inclusive growth, an improvement that pulls up both actual and potential growth rates, or the worrisome beckoning of recession in the midst of even more extreme inequality. But the report can provide comfort to the Federal Reserve, which is still inclined to hike rates and reduce the size of its balance sheet, despite the economy’s recent soft patch.
Employment creation has been the bright spot of the U.S. economy in recent years. About 17 million jobs have been added since the depth of the recession in 2009, helping to push the unemployment rate down to 4.3 percent, its lowest level in 16 years.
Yet in sharp contrast to historical experience, these encouraging developments have failed to induce two other reactions produced by a truly health labor market: robust wage growth and the return of discouraged and marginalized workers. As a result, the historic run in job creation has done little to counter the gradual hollowing-out of the middle class, the spread of anger politics, worsening inequality, and the loss of trust in the establishment and the elites.
The situation would have been worse had the Fed not responded a few years ago to the political polarization in Congress that paralyzed most policy-making entities. Sensing that, hopefully just for now, it was the “only game in town” policy-wise, the Fed boldly took on a significantly expanded policy role. It relied on a series of unconventional measures that -- due to the prolonged use of policy tools that are inevitably ill-suited for the structural task at hand -- delivers not just benefit, but also a risk of collateral damage and unintended consequences that threaten financial, institutional, political and perhaps even economic damage down the road.
Having bought time for the economy, the Fed is now inclined to normalize its policy stance before it goes from being a big part of the solution to becoming a big part of the problem. To this end, it has already hiked interest rates twice this year, signaled that it expects to hike rates again, and set out a plan for gradually reducing its record holdings of mortgage and government bonds.
Here is where Friday’s jobs report comes in.
To be comfortable in pursuing this path, the Fed needs to see further evidence of low and declining slack in the labor market. And this can come from three favorable developments, and one unfavorable one:
• Wage growth heading to, and above, an annualized 3 percent pace.
• Monthly job gains continuing in excess of 80,000 to 100,000, or what many would deem the “steady state” rate given population growth.
• A fall in the more comprehensive U-6 measure of unemployment.