03 Nov 2006 Will More Jobs Bring More Inflation?
This economy continues to surprise analysts with its resilience in the face of circumstances that have crushed previous expansions. The government announced today that the unemployment rate fell to 4.4%, its lowest level since May 2001. The report also showed that service sector activity accelerated as housing declined.
It is good news that the declining housing market does not appear to be causing wider damage to the economy. In fact, rising employment means greater confidence among a growing number of consumers. That’s good for the holiday shopping season and for the economy in general.
On the other hand, falling unemployment suggests greater demand for qualified employees, which means rising wages. Rising wages can be a contributor to inflation, especially combined with rising food and energy prices. The chances for a Fed rate cut early next year probably went out the door with today’s report. According to the Wall Street Journal, the federal-funds futures contract traded with an implied yield of 5.24% after the report was released, reflecting 4% odds on a rate cut by January, compared to 16% odds before the report. Interest bearing securities like US Treasuries also fell with the report as bondholders fear that rates may be rising.
For the past several years inflation has been contained largely by the rapidly growing productivity in this country. Companies can afford higher wages and grow profits faster without having to raise prices when they can produce more for each hour their employees work. The WSJ points out that it is a critical component of a nation’s prosperity and standard of living.
Unfortunately, this week we hit a bump in the road. Non-farm-labor productivity was flat in the third quarter compared to the second quarter, according to the Labor Department. Compared with a year earlier, productivity was up 1.3%, less than half the blazing 2.8% average rate of the past decade – a phenomenal surge that has helped economic growth in the U.S. outpace other developed nations.
According to the WSJ,U.S.productivity has risen at 3.1% a year for the past five years. Most economists attribute the boom to the Internet and other technological advances achieved in the 1990s, and to businesses’ increasing ability to make use of those advances. Recent data, however, suggest that the benefits of those breakthroughs may have begun to wane.
On the other hand, quarterly productivity numbers are volatile and subject to revision. Economists point out that much of the current slowdown in productivity is a natural consequence of the third-quarter downturn in economic growth. They expect growth to pick up in the current quarter. Productivity declines in the late cycles of economic expansions, so it is not surprising to see some declines. However, if the trend continues, it does not bode well for inflation or the economy. We are watching.