Why full employment is like filling a bathtub with water

This week is chock-full of labor market data: The Job Openings and Labor Turnover Survey came out on Tuesday, followed by ADP private sector data on Wednesday, jobless claims on Thursday, and the jobs report on Friday.

The big number many are waiting on this week is the September unemployment rate, which will come out in that Friday jobs report. Last month’s rate was 4.1%, which is interesting because of something Federal Reserve Chair Kevin Warsh said at his press conference a couple of weeks ago: “We believe that the unemployment rate is running basically consistent with full employment.”

But what does “full employment” mean?

“I guess I think of it more as like a bathtub that you're filling with water,” said Alicia Sasser Modestino, professor at Northeastern University’s School of Public Policy and Urban Affairs. “There's a certain level of water that is ideal, so that when you get in the bathtub it doesn't overflow. But you also want to be in a bathtub where there's enough water that you're going to enjoy that bath, right?”

Modestino explained that, effectively, the labor market works in a similar way.

“And so we can think about workers moving through the labor market where new workers are getting poured in, some workers are leaving for a variety of reasons,” she said. “But we always want to have a nice steady level, warm temperature — not too hot, not too cold — labor market.”

A labor market that’s just right. So, even at full employment, there are still some people without jobs.

“Zero unemployment is actually the world where wages are increasing a lot, prices are increasing a lot — nobody actually wants to live in that world,” said Eliza Forsythe, professor of economics at the University of Illinois. “I think when the Fed is thinking about full employment, they're thinking about what's the level of employment that's not leading to inflation.”

This relationship between unemployment and inflation is modeled by something called the Phillips Curve. When unemployment goes down, inflation tends to go up, because in periods of very low unemployment, there tends to be faster wage growth since workers have more negotiating power in a tight labor market.

So, is the labor market at full employment like Warsh and his colleagues seem to think?

”I think it's really tricky to say, right?” said Forsythe. “I think that the level of unemployment is decent, but then I think the fact that we're not seeing the churn means that there [are] warning signs under the hood. “

“Churn” meaning people aren’t leaving their jobs for better opportunities — and those who are without a job are having a harder time finding one. In other words, it’s a very low-hire, low-fire environment.

So, is the labor market at full employment? We don’t know. But the good news is there’s fresh data coming out on Friday that could give us a better picture of the market.