Payroll Growth Means Fed is Right to Stay on Hold: View

Today’s employment figures are welcome evidence that a real economic recovery is under way in the U.S.

That doesn’t mean there aren’t risks in the outlook at home and abroad. There’s still a lot of ground to make up and some difficult restructuring to complete. (Of the 8.8 million jobs lost since 2008, about 3.5 million have been recovered.) But the recovery looks firmer, and that’s good.

The economy added 227,000 jobs in February, according to the new report. That was a bit more than already-optimistic market analysts had expected. (The Bloomberg consensus forecast had called for a rise of 210,000.) Better still, the strong figures for December and January were revised upward, by 20,000 and 41,000 respectively, so the average monthly increase in payrolls over the three months was 245,000.By the standards of previous recoveries, that’s respectable but hardly spectacular.

The headline unemployment rate was unchanged at 8.3 percent. That’s less disappointing than you might think. Increasing numbers of people who had dropped out of the labor market began looking for work again last month, which raises measured unemployment. So long as hiring is strong enough to draw discouraged workers back into the hunt, the headline unemployment rate will understate the rate of healing in the economy.

And it is hugely desirable that discouraged workers return to the labor force. If they don’t, the unemployment rate will fall faster, but the economy’s ability to support higher living standards will be permanently impaired -- as though a part of its stock of capital had been destroyed.

Where does the report leave monetary policy? In recent congressional testimony, Federal Reserve Chairman Ben S. Bernanke sounded a note of caution about the improving labor market. Jobs are growing faster than you would expect, he said, given the relatively sluggish expansion in output. How this apparent anomaly will be resolved remains to be seen, but the latest confirmation of strength in the labor market makes it unlikely that the jobs recovery will turn out to have been an illusion.

With unemployment still much higher than it should be and labor-force participation (despite the recent improvement) too low, it’s far too soon to think of tightening monetary policy. In fact, with inflation well suppressed and short-term interest rates at zero, a case can be made for further unorthodox loosening, something the Fed has discussed and is keeping under consideration.

But the Fed’s policy-making committee was divided on this before the new jobs numbers, and the firming labor market will make inflation hawks even more reluctant to give way.

Fears of rising inflation seem exaggerated now, but they shouldn’t be dismissed. The great unknowns as the recovery proceeds are whether this exceptionally severe recession has damaged the economy’s long-term productive potential, and how far the structure of the economy needs to change as spare capacity runs down. The bigger the permanent loss of capacity, and the greater the needed realignment of the economy (making it, for instance, less dependent than in the past on investment in housing), the sooner rising demand will hit supply-side buffers.

Before that happens, the focus will need to shift to preventing inflation. Some Fed governors were already questioning the recent commitment to keep interest rates very low until the end of 2014 -- a promise that constitutes unorthodox monetary loosening in its own right.

Higher labor-force participation, as shown in February’s jobs numbers, should ease their concerns by signaling extra space for non-inflationary growth, but it probably won’t. While the Fed is divided, it will be reluctant to act one way or the other. At some point, that could be dangerous. For the moment, given the uncertainties, a holding pattern for monetary policy looks wise.

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