President's Message: Labor Market Dynamics and Inflation

Thomas C. Melzer

U.S. unemployment has been running at about 5 percent—its lowest level in 30 years—and the economic expansion is now in its seventh year. That good news, however, doesn't reveal the dynamic nature of our economy, which continues to undergo major restructuring with new firms, new products and new jobs attracting existing job holders and new entrants to the labor force. Despite major layoffs that have grabbed headlines and contributed to job insecurity, we have seen a net increase of 11 million jobs over the past five years. Today, nearly 130 million civilians have jobs, representing 64 percent of the population—the largest fraction at work outside the home ever.

Free labor markets in this country operate as an "invisible hand" directing workers to their best job opportunities. In such labor markets, there are vast currents of searching, hiring, quitting, firing and retiring. Businesses begin, expand, contract and close by the thousands. Each month's employment growth represents just a tiny segment of the job creation and destruction that takes place. Based on rough figures for the economy as a whole, monthly net employment change amounts to less than 20 percent of gross job creation. If you look at more accurate data for manufacturing, quarterly net employment change is less than 5 percent of gross job creation. Thus, for every net job gain in manufacturing, about 21 new jobs would have been created and 20 old jobs destroyed.

Some critics dismiss recent job creation, arguing that jobs have tended to be low-paying, part-time, temporary, and so forth. Yet, nearly 60 percent of net new jobs in recent years have been managerial and professional. Employment in these relatively high paid occupations has risen from 26 percent to 29 percent since 1992. Thus, despite the headlines about downsizing, the demand for skilled workers has been growing, and the "invisible hand" is supplying workers to meet that demand.

It is important to recognize that the way labor markets function is not the result of Fed actions, except in a very indirect way. The dynamics of labor markets emanate primarily from private decision makers: firms developing new products and new ways to produce, and workers developing skills to take on new jobs as opportunities become available. The Fed does play a role in making sure that price and wage signals are not distorted by inflation so that firms and workers can focus on these real factors in decision making. I like to think that the Fed has contributed to the sustainable job growth during the current expansion by providing one of the most stable and low inflation environments in history.


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