Economist Sees a Dark Side to Falling Unemployment

Job seekers wait in line to enter the Dr. King career fair in the Brooklyn borough of New York Photograph by Michael Nagle/Bloomberg

Ian Shepherdson is a nice guy. He’s also an economist, which means that he looks at the world a bit … differently. Right now, he’s concerned that the U.S. unemployment rate might continue to fall faster than the Federal Reserve is projecting.

Shepherdson thinks Fed Chairman Ben Bernanke and Vice Chairman Janet Yellen are too dovish—that is, they’re underestimating the strength of job growth. He fears the Fed’s rate-setting committee will keep interest rates too low for too long, causing inflation to jump. The Fed has said it anticipates keeping rates “exceptionally low” through the end of 2014. I wrote about the Fed’s take on this on April 5.

Shepherdson may not be right about this, but a lot of people feel the same way, so it’s worth considering the argument. He operates from a London base as chief U.S. economist for High Frequency Economics in Valhalla, N.Y. His claim: While job creation is great, it’s not healthy for unemployment to be falling so rapidly when the economy is expanding at such a modest pace. It means productivity growth is low. It was just 0.9 percent annualized in the last quarter of 2011. Crucially, Shepherdson thinks it will stay low.

His theory: Productivity was high in the early phase of the recovery because large, capital-intensive companies were able to meet rising demand, without hiring, by working their machines harder. But now the expansion has spread to companies that are less capital-intensive and have to hire as soon as demand for their goods and services picks up. Shepherdson fears that if the Fed’s low rates stimulate strong growth in output, companies will quickly run out of people to hire and the competition for labor will drive up wages, leading to inflation. He described his views in his weekly notes on April 16 and elaborated on them in a phone interview.

Bernanke and Yellen have a different explanation. They say companies overshot their job-cutting—perhaps out of fear that things would get even worse—and since then, they’ve corrected that mistake by staffing back up. That’s consistent with a fair amount of research, including some by economists at Citigroup.

Either theory, the Fed’s or Shepherdson’s, seems capable of explaining what has happened so far. But they have starkly different implications for what happens next. Shepherdson fears the labor market will overheat unless the Fed starts nudging up interest rates. The Fed’s central forecast is that unemployment will still range from 6.7 percent to 7.6 percent at the end of 2014, meaning that labor-market tightness is the last thing for anyone to worry about.

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