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What’s at stake when the Federal Reserve intervenes in today’s tight job market

About the author: JW Mason is Professor of Economics at John Jay College, City University of New York and Fellow at the Roosevelt Institute.

The job market is extremely tight, at least by the standards of recent history. This is important for monetary policy, but its importance goes beyond inflation or even material living standards. We are used to a world where workers compete for jobs. A world where companies compete for labor would be very different.

Today’s unemployment rate of 3.5% is the lowest it was at any time between 1970 and 2019. While the labor force-to-prime-age ratio is still just below its pre-pandemic level, other measures point to a labor market even hotter than at the height of the boom in the late 1990s. Both the historically high rate of workers leaving their jobs and the nearly two open positions for every unemployed person suggest that this may be the best time in most Americans’ working lives to look for a job.

How long this goes on depends in large part on the Federal Reserve, which is often concerned with whether inflation expectations are anchored. If firms and households believe that prices will rise rapidly, the argument goes, they will act in ways that encourage prices to rise, confirming those beliefs and making it harder to bring inflation back down.

Curiously, all the other expectations, which can also be anchored in different ways, are hardly discussed, suggesting quite different trade-offs.

Companies expecting weak growth, for example, are unlikely to invest in increasing capacity — making strong growth much more difficult to achieve. Workers who feel it is impossible to find a job may stop looking for one, itself confirming expectations of weak job growth. Both of these shifts in expectations played a role in the “lost decade” after the 2007 crash.

Today’s tight labor markets are shifting expectations in a different direction, which could lead to lasting changes in employment dynamics. As economist Julia Coronado notes, companies seem to have learned a lesson that recruiting may be slower and more difficult than in the past. This, in turn, makes companies reluctant to lay off workers even if demand slows.

Fewer layoffs naturally contribute to tighter labor markets – another example of self-validating expectations. But these new expectations also mean a different kind of employment relationship. A company that expects labor to be cheap and plentiful has little reason to invest in recruiting, retaining, and training its employees. Conversely, a company that cannot count on quickly hiring people with the required skills needs to focus more on developing and retaining its employees. These qualitative changes in work organization are not reflected in the aggregate employment and wage figures.

To put it bluntly, there is absolutely no labor shortage. One thing we’ve clearly learned over the past year is that overall employment doesn’t just depend on how many people are willing to work. As early as spring 2021, some economists were arguing that generous pandemic unemployment benefits were holding back job growth. When some states ended unemployment benefits early, it provided the perfect controlled test of this theory. It has been decisively refuted. As labor economist Arin Dube has shown, job growth was no faster in states that ended pandemic jobless benefits earlier than in those that kept them longer.

What is true, however, is that the types of jobs people take may depend on their other options. For the economy as a whole, today’s high rate of job turnover is a clear plus. A major reason why people can get a raise by changing jobs is probably because their new job is more valuable than their previous one. But from the perspective of employers, this is a process with winners and losers. Some companies will adapt, offering higher wages — as many hospitality and retail giants are already doing — and offering intangible benefits like predictable schedules and advancement opportunities. Tight labor markets will also favor higher productivity firms that can afford to pay higher wages. Those locked into a model that sees labor as cheap and available can struggle or fail.

Of course, it’s not just employers who have to adjust to tight labor markets. There is little doubt that the rise in unionization that we have seen in recent years is due in large part to labor market conditions. When jobs are plentiful, the fear of losing yours is less of a deterrent to going up against the boss. And people who are reasonably confident of getting at least a paycheck might be wondering if that’s all their employer owes them.

Historically, periods of rapid union growth have followed sustained growth, not depressions and crises. During the 1972 strike at GM’s Lordstown plant – one of the high points of labor struggles in the 1970s – a union leader explained why younger workers were so willing to quit their jobs:

“None of these guys came out of the old country poor and starving and grateful for any job they could get. None of them went through depression… They just won’t take the same kind of treatment their fathers did. That was a lot of what the strike was about. They want more than just a job for 30 years.”

Strikes like Lordstown have their roots not only in workplace conditions, but also in the way a sustained high-pressure economy is changing workers’ expectations of a job. Significantly, the Lordstown strikers’ demands included a say in the design and organization of the plant, and better pay and benefits.

Of course, not everyone would welcome a revival of the US labor movement or a move toward German-style codetermination. While some people see unions as a pillar of democracy and a counterweight to corporate political power, others see them as an unlawful interference with corporate rights. Either way, whether organized labor can reverse its decline is a question with implications well beyond next month’s inflation figures. And it depends very much on how long today’s tight job market lasts.

It may seem utopian to imagine a transformation in the world of work when fears of inflation and recession are dominating the headlines. But the real fantasy is imagining we could reap the benefits of a high-pressure economy — faster productivity growth, a more equal distribution of income, more resources to solve our pressing problems — without making changes to the way firms and labor markets are organized.

In his recent press briefing, Federal Reserve Chair Jerome Powell said, “We all want to go back to the job market we had before the pandemic.” Do we really all want that, or can we aim higher? But you can’t just turn back the clock anyway. An economy adapted to slow growth and an abundance of cheap labor cannot adapt to tight labor markets without undergoing profound changes.

Some may welcome an economy where chronic labor shortages mean companies are under constant pressure to increase productivity and attract and retain employees. Others may be hoping for a deep recession to reset expectations about relative labor and job scarcity. Either way, those are the stakes.

Opinions like this one are written by writers outside of the newsrooms at Barron’s and MarketWatch. They reflect the perspective and opinion of the authors. Send suggested comments and other feedback to [email protected]

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