While the unemployment rate is very low, other measures of the labor force suggest the economy is not at full employment.

A full employment economy would suggest stronger wage growth than we've seen recently.



In the mainstream media, I often hear that we are near full employment and wages are starting to rise.

So let’s talk about “full employment.”

Full employment means all the people who want to work are employed. The Fed thinks that full employment is about 4.7%. Meanwhile, the BLS tells us that unemployment is currently at 4.1%. So in theory, we are way below full employment.

Those who aren’t working are either in between jobs or have some barrier, like a criminal record or lack of skills.

But is it really that simple?

Every month, we have only a rough idea of how many people are unemployed and who might become employed. The numbers come from survey data, with all its inherent limitations.

In fact, there are two different surveys, and sometimes they wildly disagree with each other. Beyond that, what we think we “know” is mostly assumptions about what we want the data to say.

We use survey data to infer how many people are employed, how much they are paid and so on. In the process, we observe people who aren’t employed. We try to figure out why, and what might bring them back into the labor force.

It’s a giant mystery that no one has solved. Yet we make vital policy decisions based on it anyway.

How we measure full employment

Let’s look at a few different ways to measure what we mean by full employment.

BLS suggests that if you haven’t been looking for a job in the last 30 days, you don’t count as unemployed. First off, that just runs contrary to all of our personal experiences.

Many people have not been able to find a job in that timeframe and have given up looking. But if they were offered a decent paying job they would take it.

Simply counting 30 days to say they are no longer in the labor force seems rather arbitrary to me.

Let’s look at the US labor force participation rate since 1990 via the St. Louis Fed Fred database:

Mauldin Economics

There are a lot of reasons for a drop in the participation rate. And it is a very complex thing to get your data head around.

But policymakers and economists want simple solutions and answers. So they make biased assumptions and assert this is what the data means.

If you argue that we are at “full employment,” it means you expect wage inflation. Except that there’s no wage inflation. 80% of the workers are seeing very little growth at all.

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Hard facts

To prove that the change in the unemployment rate has little effect on wages, let’s hear from my friends, at 720 Global.

Below is an excerpt from their report with some graphs. The first two are the traditional Phillips curve (U-3 and recent three-month wage growth) and a modified Phillips curve, which uses the revised U-3 from above and one-year forward wage growth. (Emphasis is mine.)

720 Global via Mauldin Economics

"Both graphs … demonstrate that only 28.84% of the change in wages was due to the change in the unemployment rate. Visual inspection [of the first graph] also tells you the relationship between wages and unemployment is weak. It is this graph that has many economists declaring the Phillips curve to be irrelevant. The second graph has a (warning: economic geek speak) statistically significant R² of .7047 and a visible confirmation that the Phillips curve relationship continues to hold. Recently, Federal Reserve Bank of Chicago President Charles Evans stated, in relation to the Phillips curve, 'We don’t have a great understanding of why it’s gotten to be so flat.' Mr. Evans, perhaps employment is not as strong as you and your Fed colleagues think it is."

720 Global goes on with more math before they produce this really rather important graph:

720 Global via Mauldin Economics

If you believe that the laws of supply and demand continue to hold true, then the real unemployment rate is much closer to 9% than 4.1%.

The only reason economists and Fed officials ignore this data is that it dispels the pretty economic picture they wish to paint.

Does anyone else see a problem here?

Man sees what he wants to see and disregards the rest. If you want to see low unemployment, you find data that gives you low unemployment. You don’t look at competing measures.

And this is in spite of the fact that most Fed economists truly believe in the Phillips curve. They just don’t believe in it enough to take it to its logical conclusion like 720 Global did.