For Fed, Unemployment Is Only Part of Picture

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Conventional wisdom holds that the Federal Reserve Board will not raise overnight interest rates tomorrow. The logic holds that the Fed will not raise interest rates if the economy shows signs of weakening, and is therefore less inflationary. The popular evidence is last Friday’s weaker-than-expected labor report on new job creation and unemployment.

The Fed may decide not to raise interest rates tomorrow, but last Friday’s labor report is hardly evidence of a weakening economy. The July increase in employment of 113,000 jobs is in line with recently monthly increases. The increase in the unemployment rate to 4.8% from 4.6% is largely attributable to a rise in workers entering the labor force, especially reentrants. An unemployment rate of 4.8% is quite modest by historical standards, and less than the 5.0% rate of one year ago, when there was little concern that the economy was slowing.

More important, the unemployment rate by itself is a weak measure of economic activity or the scarcity of resources. Just ask residents of the Upper Midwest. It may come as a surprise to many of them that this region has the lowest June unemployment rates in the country (July state data are not yet available). It is well below 4%. But the region also has the slowest employment growth during the past decade, averaging much less than 0.8% growth per year. The Upper Midwest, once the epitome of the stable American middle class, has seen wages fall behind much of the rest of the country.

In June, South Dakota had a 3.0% unemployment rate, one of the lowest in the nation. Raising interest rates presumably would slow the South Dakota economy, but there is not much of an economy to slow. Americans are not flocking to South Dakota to find work; just the reverse is happening. Indeed, the most recent government data indicate that weekly wages in South Dakota were the lowest in the nation.

Anyone from Iowa can tell you their local economy is troubled. Iowa has an unemployment rate of 3.6%, but also one of the slowest economic growth rates in the country. The low unemployment rate in Iowa is not an indication that resources are scarce in the state because of an overheated economy with rampant inflation; just the opposite. Century-old houses with lead-glass windows and high ceilings go begging in Iowa no matter how low the unemployment rate. Iowa wages are well below the national average. If the Fed raises interest rates because unemployment is low in the Upper Midwest, it will do little to revive lagging local economies or find buyers for empty houses.

In contrast, California, Texas, and Washington all have unemployment rates above the national average, in part because workers still flock to those states to find jobs. Over the past decade, each of these states has averaged employment growth in excess of 1.6% annually, or more than twice the rate of employment growth in the Upper Midwest. People leave Iowa and the Dakotas to escape cold weather and to find jobs.The same house that can find no buyers in Iowa would fetch millions of dollars in California where houses, roads, and other resources are scarce because of robust economic activity. Wages in California are higher than the national average, a high unemployment rate not withstanding.

The relatively higher unemployment rate in California is not an indication of a slowing economy; just the opposite.If the Fed does not raise interest rates, it will do little to spur the already expanding economies of California, Texas, and other areas with growing labor forces and seemingly high unemployment rates. But lower interest rates might do much to help the Upper Midwest, with its paradoxically low unemployment rates.

The Fed can and should look at national unemployment rates as a part of the picture of our national economy. But unemployment rates are only weakly linked to either overall levels of economic activity or inflationary pressures. Our economy is on a slow but gentle growth path, with both regional and sectoral areas of strength and weakness. When the Fed makes its reasoned decision tomorrow, the national labor statistics released last Friday will not be decisive.

A former FCC commissioner, Mr. Furchtgott-Roth is president of Furchtgott-Roth Economic Enterprises. He can be reached at hfr@furchtgott-roth.com.


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