Two weeks of travelling in the US and Europe and finally, a Saturday morning in Highgate. Markets have had the 'notaper' from Ben Bernanke, the 'No QE' from Mark Carney and the 'No negotiation on Obamacare' which threatens to bring the US government to a halt. Hey ho. And in the foolish world of financial markets on we go to another monthly Labor Report, next Friday.
When it was still summertime, I threw out some observations on the Phillips Curve, which seems to work well in Japan, a bit in the US and very poorly in the UK. The US labour market remains hugely important for monetary policy, even if Mr Bernanke went to some pains to make us understand there are no automatic consequences of a falling unemployment rate. Markets will still be watching the jobs data (very) closely. So, here's a quote from July's Chicago Fed letter
"For the unemployment rate to decline, the U.S. economy needs to generate above-trend
job growth. We currently estimate trend employment growth to be around 80,000 jobs
per month, and we expect it to decline over the remainder of the decade, due largely
to changing labor force demographics and slower population growth"
That's a much lower estimate of trend employment growth than I might have come up with in the pub on a Thursday night. The August payroll gain was a 'disappointing' 169k and in the last twelve months the range has been between 332k and 104k, in other words, consistently well above trend. Hence the falling unemployment rate. But, this solid employment growth hasn't prevented GDP from growing by a relatively measly 1.6% in real terms. The bottom line, if I take the fine analysis from the folks at the Chicago Fed to heart, is that even if job creation continues at what Americans consider to be a paltry rate (180k or so per month of late), the unemployment rate will go on falling steadily.
Now if you don;'t believe there is any such thing as a 'NAIRU', you won't care about that. But you should be worried if you are one of those people who do think there is an unemployment rate below which wage growth accelerates (small rant here for me to repeat that the empirical connection between unemployment and wage growth is much less awful than that between unemployment and inflation).
Which brings me to a completely different topic - the Beveridge Curve. The US Federal Reserve employs armies of really talented economists, not only at the Chicago Fed. So, here is a great paper from Rand Ghayad at the Boston Fed (many thanks to Mike Green in New York for sending it to me). The Beveridge curve shows the relationship between job vacancies and the unemployment rate, which reflects the amount of friction in the labour market. There ought to be a low unemployment rate when there are lots of spare jobs going, obviously. Mr Ghayad is one of many to observe an outward shift in the Beveridge Curve, which suggests that it take more vacancies to get the US unemployment rate down than it used to. In my simple mind, that indicates more friction in the labour market. Mr Ghayad shows that this is mostly driven by those who have been out of work for longer periods of time and proposes that much of this is due to changes in how long people can receive unemployment benefits in the US. But a shift outwards in the Beveridge Curve tends to suggest that more of the unemployed are not looking for jobs as hard as they used to, or are unsuited to them. They could be people who have been out of work for a long time who no-one will hire, or they could be unemployed CDO structurers, who are ill-suited to most other tasks. We used to call such people 'outsiders' in an insider/outsider theory of the labour market which explains why the long-term unemployed don't put downward pressure on wage growth elsewhere, and why the only people who ever get to manage premiership football teams, are people who manage top-class football teams somewhere else in Europe. Professor Dennis Snower who is now the head of the Kiel Institute, had the misfortune of having to teach me about this 30 years ago. In Phillips Curve parlance, a shift outwards in the Beveridge Curve, increases the NAIRU level and if that is what is going on in the US, there is a likelihood that we will see a pick-up in wage growth as the unemployment rate falls from here.
On weekdays, when I'm earning my living as a fixed income strategist, I may worry about faster wage growth. On Saturday mornings, I say bring it on! But it does raise questions about the relationship between inflation and wage growth and it raises the intriguing question of whether the labour share of GDP, pummelled ever lower in recent years, is finally going to turn higher, at the expense of the profit share. Nice for people, not so nice for shareholders...
UK Inflation....
US wage growth (at 2.2% per annum) isn't affecting inflation (the core PCE deflator is languishing at 1.2% per annum). That may partly be because inflation is driven more by demand than wages. So if wage growth goes up because the labour force and population are growing more slowly, that also reflects sluggish overall demand. This is a neat theory to fit the facts, but is also immediately focuses my mind back on the UK. Because here, we are seeing an acceleration in population and labour force growth, notably in the South East of the country. This helps anchor wage growth, but also helps push up inflation. It pushes up inflation in the same way as is seen more frequently in emerging market economies, where population growth is a really big driver. The sectors of the UK CPI which are growing faster than overall inflation at the moment are food, drink & tobacco, housing, utilities, health and education. Away from food and drink, the price of utilities, health, education, and other services are going up largely because a growing population requires investment to increase capacity (more trains, tubes, water pipes, power stations, nurses and bin collectors) which is passed on to consumers because a cash-strapped government won;'t make the investment for us. There is good news in the latest CPI data, insofar as the price of coffee and tea, beer, shoes and cars are all falling while photographic equipment prices are falling fastest of all, but I can't help thinking that the fact UK inflation is higher than it is in the US, or Euro Area, has more to do with structural strains on services than anything else. Meanwhile, a growing population will continue to anchor wage growth (so we can all grumble) and push up the one price that doesn't get properly reflected in the CPI data - that of flats and houses.
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