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Does 5.1 percent = full employment?

Mitchell Hartman Sep 4, 2015
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The unemployment rate fell 0.2 percent to 5.1 percent in August according to the Labor Department. Unemployment is down from a peak of 10 percent in October 2009, and 6.1 percent in August 2014.

The Federal Reserve considers a base unemployment rate (the U-3 rate) of 5.0 to 5.2 percent as “full employment” in the economy.

The recovery has now achieved that level, known technically as the Non-Accelerating Inflation Rate of Unemployment, or NAIRU. Here’s what it means in lay terms, according to Lawrence Katz, Harvard economist and National Bureau of Economic Research associate:

“There is a balance between employers looking for workers, and workers looking for jobs.”

This sweet spot for unemployment should be good for workers.

As labor economist Gary Burtless at the Brookings Institution explains, at this level of unemployment, classic economic theory predicts that a tight labor market will develop.

“Employers have a tough time filling job vacancies, and they start to bid up wages, either to keep their employees from leaving, or to recruit good employees from someone else,” Burtless says.

Jodi Chavez manages offices in California for the financial services staffing and recruitment firm Accounting Principals, a division of Adecco. Chavez says employers in the industry realize that as they post more job openings to keep up with expanding business, there are fewer candidates gunning for those jobs. So bargaining power is beginning to shift to the employee or potential employee.

“If you’re going to make a hiring decision, you need to make it quickly, because these candidates are not on the market very long,” Chavez says. “There has been a slight increase in salaries. We’re not to the point where we’re seeing sign-on bonuses, or a high demand for increased salaries to obtain those employees.”

And the fact that employers across the economy are not having to boost salaries significantly to compete for workers (as shown by the nominal average hourly wage growth of 2.2 percent year over year in the latest employment report), suggests to Katz that there are still a lot of potential workers waiting in the wings. And that labor market slack isn’t being captured fully in the “full employment” unemployment rate of 5.1 percent. The pool of potential workers making up that labor market slack includes people who are discouraged but able to work; those sheltering in school; those working part time and looking for full-time work; and those looking for a job (and salary) that better matches their education and experience.

“My take is, even though the unemployment rate looks very low at 5.1 percent, I don’t think we’re quite at full employment,” Katz says.

Economist Michael Strain at the American Enterprise Institute agrees.

“We now have a healthy unemployment rate, and we’re adding jobs at a healthy rate, enough to absorb people into the workforce and account for the growing population,” says Strain. “At the same time, we have very low participation in the workforce. We have broader measures of unemployment that have not recovered from the Great Recession. The basic logic is that if the economy were running out of labor market slack, employers would be bidding up wages to attract new workers and to retain existing workers, who now have a lot of options. We would see an acceleration of wage growth. And we’re just not seeing that.”

Katz believes that the Federal Reserve should maintain monetary stimulus and not raise interest rates yet, to let unemployment fall into the mid-4-percent range for several years, if possible. He points to the late 1990s, when unemployment fell below what was then thought to be the rate of full employment, delivering strong income gains without sparking runaway inflation. He says a repeat would lead to the re-employment of many workers who dropped out of the labor force in the Great Recession, and would likely deliver broad-based wage gains (well above the rate of inflation) for middle-class workers.

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