Some folks are speculating that the US economy is approaching full employment. In this post I'm going to explain why I don't believe that is so. I'm going to describe a Phillips curve like relationship between the core rate of inflation, wage growth and job growth. This is something of a work in progress. It seems to work well for the US economy, and a very similar approach appears to work for the UK, but I have not applied it to other economies yet.
On the y-axis I will plot the percentage growth in the product of wages and employment. For example, for January 1965 wage growth is 3.2% and employment growth is 3.6%. The quantity (wages*employment) grows by a 7% and this I plot on the y-axis.
The US economy seems to take time to respond to changes in employment and wages. On the x-axis I will plot core inflation delayed by 21 months. For example, for the January 1965 data point I use the inflation from October 1966.
The best fit line shown on the chart predicts 2.2% inflation in October 2017 based on current rates of wage and job growth. The growth in (wages*employment) is currently 4.4%, and it has never gone above 7% since 1992. In that time inflation has stayed under 3%.
Under what circumstances should we be concerned about a return of inflation? When inflation took off in the late 1960s the growth of (wages*employment) was a little over 8%. From 1972 until 1981 it never fell below 7%. As long as it stays under 7%, inflation should stay low.
With growth in (wages*employment) at 4.4% as of January 2016, there is clearly a lot of room for stimulating the economy. When we approach full employment, wage growth should rise substantially.
Notes and data sources
1/ All data is from FRED. For wages I am using the "Average hourly earnings of production and non-supervisory employees: Total Private (AHETPI) " The data is seasonally adjusted. For January of each year I take the percent change from the previous year.
2/ For employment I am using "All employees : total nonfarm payrolls (PAYEMS)" seasonally adjusted. For January of each year I take the percentage change from the previous year.
3/ For core inflation I am using "Consumer Price Index for All Urban Consumers: All Items Less Food and Energy (CPILFESL)" I take the annual rate of change delayed by 21 months. For example, (earnings growth * employment growth) for January 1965 is plotted against inflation for October 1966.
4/ Care needs to be taken with the arithmetic. For example, wage growth of 3.2% is a factor of 1.032. Employment growth of 3.6% is a factor of 1.036. Earnings growth * employment growth = 1.032*1.036 = 1.069 which is equivalent to 6.9%.