Can The Economy Stand A Million More Jobs?

Among the monetary mandarins at the Federal Reserve, it is a long-held dogma that too much employment can be a dangerous thing. That's because Fed officials--and most private economists--believe that when the jobless rate dips too low, employers are forced to bid up wages to attract the best workers. With payrolls representing two-thirds of business costs, inflation is certain to rise.

At what point is unemployment too low? Conventional wisdom at the central bank pegs the threshold at about 6%, based on past business cycles (chart). But there is growing evidence that the Fed may be overestimating this crucial pressure point--known in econospeak as the "nonaccelerating-inflation rate of unemployment" (NAIRU).

The proof: The jobless rate, now 5.5%, has been below 6% for 14 months. The employment cost index, which measures wages and salaries, rose just 2.8% over the past year, vs. 2.9% during the preceding 12 months. And recent wage hikes seem to be offset by productivity increases. "In every business cycle, there are conventional wisdoms that prove to be myths--and the 6% NAIRU is proving to be a myth," says Allen L. Sinai, chief economist for Global Economic Advisers of Lehman Brothers Inc. He pegs the current NAIRU at 5.2%.

NAIRU LOBBYING. If Sinai is right, that means the economy can accommodate a million more jobs. A lower NAIRU could encourage Fed Chairman Alan Greenspan to cut the Federal Funds rate, which banks charge each other for overnight loans. But the Federal Reserve chief has yet to be convinced. The Federal Open Market Committee he heads declined on Nov. 15 to lower the Fed Funds rate from 5.75%. That's an unusually high level for the rate during a period of such low inflation.

It's not that some economists haven't been lobbying the Fed to plumb for a lower NAIRU. But with the economy running at capacity, Greenspan and his allies have kept to a slightly restrictive policy for fear of losing their hard-fought victories in keeping inflation under control. "I don't think the Fed ought to be conducting experiments like this," says J. Alfred Broaddus Jr., president of the Federal Reserve Bank of Richmond, Va. NAIRU "is not a toggle switch," adds Federal Reserve Governor Lawrence B. Lindsey. "Inflation can still come into the system."

Indeed, there are some new signs that real wages are finally beginning to climb again after years of stagnation. Even so, Fed insiders generally believe wage pressures that could drive up inflation remain restrained. Fed economists cite structural changes in the labor market--such as a larger global pool of workers--and heavy capital spending on labor-saving technology. That allows employers to offset any wage increases with higher productivity. "We may be experiencing a positive supply-side shock," says Harvey Rosenblum, research director at the Federal Reserve Bank of Dallas. "It has made me pause and wonder if NAIRU is lower than we thought."

Rosenblum and a few other Fed officials are warming to the idea that the NAIRU may be 5.5%. But Fed Vice-Chairman Alan S. Blinder, a former economic adviser to the Clinton Administration, says the threshold may even be lower than that. "There's not enough data to change my mind, but I would not rule out the possibility," he says. Another Fed official argues that for every point that joblessness is below NAIRU for a year, inflation rises just a half-point--leaving plenty of time to head off any emerging wage pressures.

BIGGEST SKEPTIC. Despite growing comfort at the Fed with the current jobless rate, Greenspan remains the biggest skeptic. Fed watchers say that he still doubts the economy can handle unemployment lower than 6% without triggering wage pressures. Greenspan hinted as much in an Oct. 19 speech, noting that while the downsizing trend has left employees docile, at some point "workers will perceive that it no longer makes sense to trade off wage progress for incremental gains in expected job security."

With the expansion in its fourth year, it's hard to quibble with the Fed chairman's caution. Still, with unemployment and inflation both remaining at such low levels, it may be time for Greenspan to shake off his NAIRU jacket and give labor markets some more room to move.

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