Why Does the Economy Remain Hot? ---Fed Policy Started In A Big Hole And Is Still Too Easy
The US economy added 311,000 jobs in February, following a blockbuster gain of 504,000 in January. The relatively strong growth in February contradicts the notion that unseasonable warm weather fueled January's increase. To be sure, even against a much higher base, hiring in February proved to be exceptionally strong.
If job growth alone is not a worry for the Fed, so should wage growth. Average hourly earnings for non-supervisory workers (which covers 80% of the private workforce) rose 0.5%, up from 0.3% in the prior month, and stands at 5.3% over the comparable period one year ago.
Many, including policymakers, are probably perplexed about how the economy can remain resilient after nearly 500 basis points of fed rate hikes. The answer to the puzzle is the starting point.
The chart below compares the nominal and real federal funds rates since the mid-1960s. In 2022, when the Fed started to hike official rates and reverse monetary accommodation, the federal funds rate was minus 600 basis points. There are only two other periods when real federal funds were so low, 1975 and 1980. Both at the end of recessions.
In 1975, the economy had just ended a prolonged recession, and in 1980 the economy had experienced a government-induced credit crunch/recession that triggered, at that time, the sharpest quarterly contraction on record. In both episodes, the labor markets were soft, with the unemployment rate between 7.5% and 10%.
In early 2022, when the Fed started to lift official rates, the jobless rate was 3.6%, and it's still 3.6% one year later. History argues that barring a financial accident of significant proportion, the Fed needs to lift the official rate above the core CPI inflation rate, which currently stands at 5.6%.