October 3, 2022


US employers added jobs at a rapid pace in July – which could lead to problems going forward.

The Labor Department said the US economy added 528,000 jobs in July, far exceeding expectations of 258,000 jobs, indicating that the labor market has not calmed down after three rounds of interest rate hikes by the Federal Reserve.

It’s clearly good news that a lot of Americans have found jobs. The unemployment rate has fallen to 3.5 percent, matching the pre-pandemic low in Trump’s economy. The unrestricted unemployment rate was 3.458 percent, making it the lowest rate since the 1970s.

In a low inflationary environment with a growing economy, as we enjoyed under President Joe Biden’s predecessor, that would undoubtedly be good news. In Biden’s economy, which has been suffering from high inflation for four decades and a shrinking economy, there is much to worry about.

The jump in payrolls was accompanied by a significant increase in average hourly earnings. More workers plus higher wages leads to more demand in the economy. In the near term, this is likely to lead to higher core inflation, particularly in the service sector. When the Labor Department releases its Consumer Price Index for July next week, it will likely show that core inflation has eased slightly due to lower gas prices but core inflation is likely to continue to rise. Economists consider this to be particularly concerning because core inflation – inflation minus food and fuel – is a leading indicator of future inflation. So higher core prices mean inflation will stay higher for a longer period.

Massive employment is also an indication of inflationary forces. Businesses are renting when they are flooded with demand and 528,000 jobs are signaling an ebb and flow of demand. The services sector added 402,000 jobs in July, including nearly 100,000 jobs in leisure and hospitality. Education and Health Services added 122,000, the most ever outside of the May-July period to reopen the hiring spree. Companies that see enough demand to bring in many workers will raise prices – especially because of their higher labor and material costs.

No wonder the market is convinced that the Fed will have to maintain its ability to accelerate interest rates during the September meeting. There are even whispers about the possibility of an emergency meeting if the CPI number comes out too hot next week, although it seems unlikely that we will raise the inflation numbers enough to warrant that.

The jump in employment is also likely to trigger another downward skew in labor productivity. Government measures productivity simply by dividing economic output by hours worked. When the economy shrank in the first quarter while salaries grew rapidly, productivity fell 7.3 percent. This was the biggest drop in labor productivity since 1947. We’ll get the second-quarter productivity number next week and economists expect it to drop by 4.5 percent, which is overly optimistic. If the forecast is correct, it would be the worst drop – except for the previous quarter – since 1981, when productivity fell 5.1 percent. The jump in employment in July likely means that the third quarter will see productivity decline as well.

Lower productivity with higher wages means higher labor costs. In the first quarter, unit labor costs — the dollars spent on labor to produce a unit of output — jumped 12.6 percent. It is expected to rise 10 percent in the second quarter. The wage gains in July and the lower labor productivity we expect are likely to push labor costs up further.

When unit labor costs rise in a low-inflation environment, both economic theory and empirical studies suggest that the rise does not necessarily push inflation higher. In a highly inflationary environment, when inflation expectations are rising and prices have recently been rising, unit labor costs will likely lead to additional inflation. What’s more, when unit labor costs rise due to an explosion in labor demand – rather than a contraction in supply – they are more likely to contribute to inflation. Moreover, when unit labor costs rise rapidly in the service sector – as they are – they are likely to contribute to inflation because it is difficult to replace services with imports or improve productivity through technology.

A while ago, people used to talk about moderate economy. The idea was that the economy was just right, neither too hot nor too cold, just as when Goldilooks found little bear porridge. Today’s job numbers suggest we may be seeing an economy at the other end of the tale, when Goldilocks wakes up surrounded by the three bears and has to fling herself out the window to escape into the dark woods, never to be heard from again.



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