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Surprisingly Strong Jobs Report

Photo from Lena Buonanno

When the Bureau of Labor Statistics’ Employment Situation report is released on the first Friday of each month economists and policymakers—notably including the members of the Federal Reserve’s Federal Open Market Committee (FOMC)—focus on the change in total nonfarm payroll employment as recorded in the establishment, or payroll, survey. That number gives what is generally considered to be the best indicator of the current state of the labor market. The most recent report showed a surprisingly strong net increase of 336,000 jobs during September. (The report can be found here.)

According to a survey by the Wall Street Journal, economists had been expecting an net increase in jobs of only 170,000. The larger than expected increase indicated that the economy might be expanding more rapidly than had been thought, raising the possibility that the FOMC might increase its target for the federal funds rate at least once more before the end of the year.

To meet increases in the growth of the U.S. working-age population, the economy needs to increase the total jobs available by approximately 80,000 jobs per month. A net increase of more than four times that amount may be an indication of an overheated job market. As always, one difficulty with drawing that conclusion is determing how many more people might be pulled into the labor market by a strong demand for workers. An increase in labor supply can potentially satisify an increase in labor demand without leading to an acceleration in wage growth and price inflation.

The following figure shows the employment-to-population ratio for workers ages 25 to 54—so-called prime-age workers—for the period since 1985. In September 2023, the ratio was 80.8 perccent, down slightly from 80.9 percent in August, but above the levels reached in early 2020 just before the effects of the Covid–19 pandemic were felt in the United States. The ratio was still below the record high of 81.9 percent reached in April 2000. The population of prime-age workers is about 128 million. So, if the employment-population ratio were to return to its 2000 peak, potentially another 1.3 million prime-age workers might enter the labor market. The likelihood of that happening, however, is difficult to gauge.

A couple of other points about the September employment report. First, it’s worth keeping in mind that the results from the establishment survey are subject to often substantial revisisons. The figure below shows the revisions the BLS has released as of October to their preliminary estimates for each month of 2023. In three of these eight months the revisions so far have been greater than 100,000 jobs. As we discuss in Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1 and Essentials of Economics, Chapter 13, Section 13.1), the revisions that the BLS makes to its employment estimates are likely to be particularly large when the economy is about to enter a period of significantly lower or higher growth. So, the large revisions to the preliminary employment estimates in most months of 2023 may indicate that the surprisingly large preliminary estimate of a 336,000 increase in net employment will be revised lower in coming months.

Finally, data in the employment report provides some evidence of a slowing in wage growth, despite the sharp increase in employment. The following figure shows wage inflation as measured by the percentage increase in average hourly earnings (AHE) from the same month in the previous year. The increase in September was 4.2 percent, continuing a generally downward trend since March 2022, although still somewhat above wage inflation during the pre-2020 period.

As the following figure shows, September growth in average hourly earnings measured as a compound annual growth rate was 2.5 percent, which—if sustained—would be consistent with a rate of price inflation in the range of the Fed’s 2 percent target. (The figure shows only the months since January 2021 to avoid obscuring the values for recent months by including the very large monthly increases and decrease during 2020.)

As we note in this blog post, the employment cost index (ECI), published quarterly by the BLS, measures the cost to employers per employee hour worked and can be a better measure than AHE of the labor costs employers face. The first figure shows the percentage change in ECI from the same quarter in the previous year. The second figure shows the compound annual growth rate of the ECI. Both measures show a general downward trend in the growth of labor costs, although the measures are somewhat dated because the most recent values are for the second quarter of 2023.

Ultimately, the key question is one we’ve considered in previous blog posts (most recently here) and podcasts (most recently here): Will the Fed be able to achieve a soft landing by bringing inflation down to its 2 percent target without triggering a recession? The September jobs report can be interpreted as increasing the probability of a soft landing if the slowing in wage growth is emphasized but decreasing the probability if the Fed decides that the strong employment growth is real—that is, the September increase is not likely to be revised sharply lower in coming months—and requires additional increases in the target for the federal funds rate. It’s worth mentioning, of course, that factors over which the Fed has no control, such as a federal government shutdown, rising oil prices, or uncertainty resulting from the attack on Israel by Hamas, will also affect the likelihood of a soft landing.

The Labor Market Continues to Cool

As we discussed in this post, most recent data are consistent with the labor market having cooled, which should reduce upward pressure on wages and prices. On Friday morning, the Bureau of Labor Statistics (BLS) released its employment report for August 2023. (The report can be found here.) On balance, the data in the report are consistent with the labor market continuing to cool.

Data from the establishment survey showed an increase in payroll employment of 187,000, which is close to the increase of 170,000 economists surveyed by the Wall Street Journal had forecast. The following figure shows monthly changes in payroll employment since January 2021.

Although the month-to-month changes have been particularly volatile during this period as the U.S. economy recovered from the Covid–19 recession, the general trend in job creation has been downward. The following table shows average monthly increases in payroll employment for 2021, 2022, and 2023 through August. In the most recent three-month period, the average monthly increase in employment was 150,000.

Period	Average Monthly Increases in Employment
2021	606,000
2022	399,000
Jan.-Aug. 2023	236,000

The BLS revised downward its previous estimates of employment increases in June and July by a combined 110,000. The changes to the estimate of the employment increase for June are particularly notable. As the following graph shows, on July 7, the BLS initially estimated the increase as 209,000. The BLS’s first revision on August 4, lowered the estimate to an increase of 187,000. The BLS’s second revision on September 1, lowered the estimate further to 105,000. In other words, the BLS now estimates that employment increased by only half as much in June as it initially reported. As we discuss in Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1 and Essentials of Economics, Chapter 13, Section 13.1), the revisions that the BLS makes to its employment estimates are likely to be particularly large when the economy is about to enter a period of significantly lower or higher growth. So, the large revisions to the June employment estimate may indicate that during the summer economic growth slowed and labor market conditions eased.

Data from the household survey showed the unemployment rate increasing from 3.5 percent in July to 3.8 percent in August. The following figure shows that the unemployment rate has fluctuated in a narrow range since March 2022. Employment as estimated from the household survey increased by 222,000. The seeming paradox of the number of people employed and the unemployment rate both increasing is accounted for by the substantial 736,000 increase in the labor force.

Finally, as the first of the following figures shows, measured as the percentage change from the same month in the previous year, the increase in average hourly earnings (AHE) remained in its recent range of between 4.25 and 4.50 percent. That rate is down from its peak in mid-2022 but still above the rate of increase in 2019, before the pandemic. But, as the second figure shows, if we look at the compound rate of increase in AHE—that is the rate at which AHE would increase for the year if the current rate of monthly increase persisted over the following 11 months—we can see a significant cooling in the rate at which wages are increasing.

As a reminder, AHE are the wages and salaries per hour worked that private, nonfarm businesses pay workers. AHE don’t include the value of benefits that firms provide workers, such as contributions to 401(k) retirement accounts or health insurance. As an economy-wide average they suffer from a composition effect during periods in which employment either increases or decreases substantially because the mix of high-wage and low-wage workers may change. AHE are also subject to significant revisions. Therefore, short-range changes in AHE can sometimes be misleading indicators of the state of the labor market.

Data Indicate Continued Labor Market Easing

A job fair in Albuquerque, New Mexico earlier this year. (Photo from Zuma Press via the Wall Street Journal.)

In his speech at the Kansas City Fed’s Jackson Hole, Wyoming symposium, Fed Chair Jerome Powell noted that: “Getting inflation back down to 2 percent is expected to require a period of below-trend economic growth as well as some softening in labor market conditions.” To this point, there isn’t much indication that the U.S. economy is experiencing slower economic growth. The Atlanta Fed’s widely followed GDPNow forecast has real GDP increasing at a rapid 5.3 percent during the third quarter of 2023.

But the labor market does appear to be softening. The most familiar measure of the state of the labor market is the unemployment rate. As the following figure shows, the unemployment rate remains very low.

But, as we noted in this earlier post, an alternative way of gauging the strength of the labor market is to look at the ratio of the number of job openings to the number of unemployed workers. The Bureau of Labor Statistics (BLS) defines a job opening as a full-time or part-time job that a firm is advertising and that will start within 30 days. The higher the ratio of job openings to unemployed workers, the more difficulty firms have in filling jobs, and the tighter the labor market is. As indicated by the earlier quote from Powell, the Fed is concerned that in a very tight labor market, wages will increase more rapidly, which will likely lead firms to increase prices. The following figure shows that in July the ratio of job openings to unemployed workers has declined from the very high level of around 2.0 that was reached in several months between March 2022 and December 2022. The July 2023 value of 1.5, though, was still well above the level of 1.2 that prevailed from mid-2018 to February 2022, just before the beginning of the Covid–19 pandemic. These data indicate that labor market conditions continue to ease, although they remain tighter than they were just before the pandemic.

The following figure shows movements in the quit rate. The BLS calculates job quit rates by dividing the number of people quitting jobs by total employment. When the labor market is tight and competition among firms for workers is high, workers are more likely to quit to take another job that may be offering higher wages. The quit rate in July 2023 had fallen to 2.3 percent of total employment from a high of 3.0 percent, reached in both November 2021 and April 2022. The quit rate was back to its value just before the pandemic. The quit rate data are consistent with easing conditions in the labor market. (The data on job openings and quits are from the BLS report Job Openings and Labor Turnover—July 2023—the JOLTS report—released on August 29. The report can be found here.)

In his Jackson Hole speech, Powell noted that: “Labor supply has improved, driven by stronger participation among workers aged 25 to 54 and by an increase in immigration back toward pre-pandemic levels.” The following figure shows the employment-population ratio for people aged 25 to to 54—so-called prime-age workers. In July 2023, 80.9 percent of people in this age group were employed, actually above the ratio of 80.5 percent just before the pandemic. This increase in labor supply is another indication that the labor market disruptions caused by the pandemic has continued to ease, allowing for an increase in labor supply.

Taken together, these data indicate that labor market conditions are easing, likely reducing upward pressure on wages, and aiding the continuing decline in the inflation rate towards the Fed’s 2 percent target. Unless the data for August show an acceleration in inflation or a tightening of labor market conditions—which is certainly possible given what appears to be a strong expansion of real GDP during the third quarter—at its September meeting the Federal Open Market Committee is likely to keep its target for the federal funds rate unchanged.

Unraveling the Mysteries of the May 2023 Employment Situation Report

(Photo from the Associated Press via the Wall Street Journal.)

During most periods, the “Employment Situation” report that the Bureau of Labor Statistics issues on the first Friday of each month includes the most closely watched macroeconomic data. Since the spring of 2021, high inflation rates have made the BLS’s “Consumer Price Index Summary” at least a close second in interest to the employment report. The data in the CPI report is usually more readily comprehensible than the data in the employment report. So, we think it’s worth class time to go into some of the details of the employment report, as we do in Macroeconomics, Chapter 9, Section 9.1, Economics, Chapter 19, Section 19.1, and Essentials of Economics, Chapter 13, Section 13.1.

When the BLS released the May employment report, the Wall Street Journal noted that: “Employers added 339,000 jobs last month; unemployment rate rose to 3.7%.” Employment increased … but the unemployment rate also rose? How is that possible? One key to understanding media accounts of the report is to note that the report contains data from two separate surveys: 1) the household survey and 2) the employment or establishment survey. As in the statement just quoted from the Wall Street Journal, media accounts often mix data from the two surveys.

The data showing an increase of 339,000 jobs in May are from the payroll survey, while the data showing that the unemployment rate rose are from the household survey. Below we reproduce part of the relevant table from the report showing some of the data from the household survey. Note that total employment in the household survey falls by 310,000, so there appears to be no contradiction to explain—the unemployment rate increased because the number of people employed fell and the number of people unemployed rose. But why, then, did employment rise in the payroll survey?

Employment can rise in one survey and fall in the other because: 1) the types of employment measured in the two series differ, 2) the periods during which the data are collected differ, and 3) because of measurement error. The household survey uses a broader measure of employment that includes several categories of workers who are not included in the payroll survey: agricultural workers, self-employed workers, unpaid workers in family businesses, workers employed in private households rather than in businsses, and workers on unpaid leave from their jobs. In addition, the payroll employment numbers are revised—sometimes substantially—as additional data are collected from firms, while the household employment numbers are subject to much smaller revisions because data in the household survey are collected during a single week. A detailed discussion of the differences between the employment measures in the two series can be found here.

Usefully, the BLS publishes a series labeled “Adjusted employment” that estimates what the value for household employment would be if the household survey was measuring the same categories of employment as the payroll survey. In this case, the adjusted employment series shows an increase in employment in May of 394,000—close to the payroll survey’s increase of 339,000.

To summarize, the May employment report indicates that payroll employment increased, while the non-payroll categories of household employment declined, and the unemployment rate rose. Note also in the table above that the number of people counted as not being in labor force rose slightly and the employment-population ratio fell slightly. Average weekly hours (not shown in the table above) decreased slightly from 34.4 hours per week to 34.3.

A reasonable conclusion from the report is that the labor market remains strong, although it may have weakened slightly. Prior to release of the report, there was much speculation in the business press about how the report might affect the deliberations of the Federal Reserve’s Federal Open Market Committe (FOMC) at its next meeting to be held on June 13th and 14th. The report showed stronger employment growth than economists surveyed by Dow Jones had expected, indicating that the FOMC was likely to remain concerned that a tight labor market might continue to put upward pressure on wages, which firms could pass through to higher prices. Members of the FOMC had been signalling that they were likely to keep their target for the federal funds rate unchanged in June. The reported employment increase was likely not large enough to cause the FOMC to change course.

A Handy Way to Track Recession Indicators

The Bureau of Labor Statistics is housed in the U.S. Department of Labor. (Photo from don.gov site.)

In a blog post at the end of August, we noted that real GDP declined during the first two quarters of 2022. On September 29, the Bureau of Economic Analysis (BEA) slightly revised the real GDP data, but after the revisions the BEA’s estimates still showed real GDP declining during those quarters.

A popular definition of a recession is two consecutive quarters of declining real GDP. But, as we noted in the earlier blog post, most economists do not follow this definition. Instead, for most purposes, economists rely on the National Bureau of Economic Research’s business cycle dating, which is based on a number of macroeconomic data series. The NBER defines a recession as “a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.” The NBER discusses its approach to business cycle dating here.

The Federal Reserve Bank of St. Louis’s invaluable FRED economic data site has collected the data series that the NBER’s Business Cycle Dating Committee relies on when deciding when a recession began. The FRED page collecting these data can be found here.

Note that although the Business Cycle Dating Committee analyzes a variety of data series, “In recent decades, the two measures we have put the most weight on are real personal income less transfers and nonfarm payroll employment.” The following figures show movements in those two data series. These data series don’t give a strong indication that the economy was in recession during the first half of 2022. Real personal income minus transfer payments did decline by 0.4 percent between January and June 2022 (before increasing during July and August), but nonfarm payroll employment increased by 1.4 percent during the same period (and increased further in July and August).

As we noted in our earlier blog post, the message from most data series other than real GDP seems to be that the U.S. economy was not in a recession during the first half of 2022.

Should the Fed Be Looking at the Median CPI?

For years, all the products for sale in Dollar Tree stores had a price of $1.00 or less. But as inflation increased, the company had to raise its maxium prices to $1.25. (Thanks to Lena Buonanno for sending us the photo.)

There are multiple ways to measure inflation. Economists and policymakers use different measures of inflation depending on the use they intend to put the measure of inflation to. For example, as we discuss in Macroeconomics, Chapter 9, Section 9.4 (Economics, Chapter 19, Section 19.4), the Bureau of Labor Statistics (BLS) constructs the consumer price index (CPI) as measure of the cost of living of a typical urban household. So the BLS intends the percentage change in the CPI to measure inflation in the cost of living as experienced by the roughly 93 percent of the population that lives in an urban household. (We are referring here to what the BLS labels CPI–U. As we discuss in this blog post, the BLS also compiles a CPI for urban wage earners and clerical workers (or CPI–W).)

As we discuss in an Apply the Concept in Chapter 15, Section 15.5, because the Fed is charged by Congress with ensuring stability in the general price level, the Fed is interested in a broader measure of inflation than the CPI. So its preferred measure of inflation is the personal consumption expenditures (PCE) price index, which the Bureau of Economic Analysis (BEA) issues monthly. The PCE price index is a measure of the price level similar to the GDP deflator, except it includes only the prices of goods and services from the consumption category of GDP. Because the PCE price index includes more goods and services than the CPI, it is suits the Fed’s need for a broader measure of inflation. The Fed uses changes in the PCE to evaluate whether it’s meeting its target of a 2 percent annual inflation rate.

In using either the percentage change in the CPI or the percentage change in the PCE, we are looking at what inflation has been over the previous year. But economists and policymakers are also looking for indications of what inflation may be in the future. Prices of food and energy are particularly volatile, so the BLS issues data on the CPI excluding food and energy prices and the BEA does the same with respect to the PCE. These two measures help avoid the problem that, for example, a period of high gasoline prices might lead the inflation rate to temporarily increase. Note that inflation caclulated by excluding the prices of food and energy is called core inflation.

During the surge in inflation that began in the spring of 2021 and continued into the fall of 2022, some economists noted that supply chain problems and other effects of the pandemic on labor and product markets caused the prices of some goods and services to spike. For example, a shortage of computer chips led to a reduction in the supply of new cars and sharp increases in car prices. As with temporary spikes in prices of energy and food, spikes resulting from supply chain problems and other effects of the pandemic might lead the CPI and PCE—even excluding food and energy prices—to give a misleading measure of the underlying rate of inflation in the economy.

To correct for this problem, some economists have been more attention to the measure of inflation calculated using the median CPI, which is compiled monthly by economists at the Federal Reserve Bank of Cleveland. The median CPI is calculated by ranking the price changes of every good or service in the index from the largest price change to the smallest price change, and then choosing the price change in the middle. The idea is to eliminate the effect on measured inflation of any short-lived events that cause the prices of some goods and services to be particularly high or particularly low. Economists at the Cleveland Fed have conducted research that shows that, in their words, “the median CPI provides a better signal of the underlying inflation trend than either the all-items CPI or the CPI excluding food and energy. The median CPI is even better at forecasting PCE inflation in the near and longer term than the core PCE price index.”

The following figure shows the three measures of inflation using the CPI for each month since January 2019. The red line shows the unadjusted CPI, the green line shows the CPI excluding food and energy prices, and the blue line shows median CPI. To focus on the inflation rate in a particular month, in this figure we calculate inflation as the percentage change in the index at an annual rate. That is, we calculate the annual inflation rate assuming that the inflation rate in that month continued for a year.

Note that for most of the period since early 2021, during which the inflation rate accelerated, median inflation was well below inflation measured by changes in the unadjusted CPI. That difference reflects some of the distortions in measuring inflation arising from the effects of the pandemic.

But the last two values—for July and August 2022—tell a different story. In those months, inflation measured by changes in the CPI excluding food and energy prices or by changes in median CPI were well above inflation measured by changes in the unadjusted CPI. In August 2022, the unadjusted CPI shows a low rate of inflation—1.4 percent—whereas the CPI excluding food and energy prices shows an inflation rate of 7.0 percent and the median CPI shows an inflation rate of 9.2 percent.

We should always be cautious when interpreting any economic data for a period as short as two months. But data for inflation measured by the change in median CPI may be sending a signal that the slowdown in inflation that many economists and policymakers had been predicting would occur in the summer of 2022 isn’t actually occurring. We’ll have to await the release of future data to draw a firmer conclusion.

Sources: Michael S. Derby, “Inflation Data Scrambles Fed Rate Outlook Again,” Wall Street Journal, September 14, 2022; Federal Reserve Bank of Cleveland, “Median CPI,” clevelandfed.org; and Federal Reserve Bank of St. Louis.

Solved Problem: How Can Total Employment and the Unemployment Rate Both Increase?

Supports: Macroeconomics, Chapter 9, Section 9.1, Economics Chapter 19, Section 19.1, and Essentials of Economics, Chapter 13, Section 13.1.

As it does on the first Friday of each month, on September 2, 2022, the U.S. Bureau of Labor Statistics (BLS) released its “Employment Situation” report for August 2022. According to the household survey data in the report, total employment in the U.S. economy increased in August by 442,000 compared with July. The unemployment rate rose from 3.5 percent in July to 3.7 percent in August. According to the establishment survey, the total number of workers on payrolls increased in August by 315,000 compared with July.

How are the data in the household survey collected? How are the data in the establishment survey collected?
Why are the estimated increases in employment from July to August 2022 in the two surveys different?
Briefly explain how it is possible for the household survey to report in a given month that both total employment and the unemployment rate increased.

Solving the Problem

Step 1: Review the chapter material. This problem is about how the BLS reports data on employment and unemployment, so you may want to review Chapter 9, Section 9.1, “Measuring the Unemployment Rate, the Labor Force Participation Rate, and the Employment–Population Ratio.”

Step 2: Answer part a. by explaining how the data from the two surveys are collected. As discussed in Section 9.1, the data in the household survey is from interviews with a sample of 60,000 households, chosen to represent the U.S. population. The data in the establishment survey—sometimes called the payroll survey in media stories—is from a sample of 300,000 establishments (factories, stores, and offices).

Step 3: Answer part b. by explaining why the estimated increase in employment is different in the two surveys. First note that the BLS intends the surveys to estimate two different measures of employment. The household survey includes people working at jobs of all types, including people who are self-employed or who are unpaid family workers, whereas the establishment survey includes only people who appear on a non-agricultural firm’s payroll, so the self-employed, farm workers, and unpaid family workers aren’t counted. Second, the data are collected from surveys and so—like all estimates that rely on surveys—will have some measurement error. That is, the actual increase in employment—either total employment in the household survey or payroll employment in the establishment survey—is likely to be larger or smaller than the reported estimates. The estimates in the establishment survey are revised in later months as the BLS receives additional data on payroll employment. In contrast, the estimates in household survey are ordinarily not revised because they are based only on a survey conducted once per month.

Step 4: Answer part c. by explaining how in a given month the household survey may report an increase in both employment and the unemployment rate. The BLS’s estimate of the unemployment is calculated from responses to the household survey. (The establishment survey doesn’t report an estimate of the unemployment rate.) The unemployment rate equals the total number of people unemployed divided by the labor force, multiplied by 100. The labor force equals the sum of the employed and the unemployed. If the number of people employed increases—thereby increasing the denominator in the unemployment rate equation—while the number of people unemployed remains the same or falls, as a matter of arithmetic the unemployment rate will have to fall.

The BLS reported that the unemployment rate in August 2022 rose even though total employment increased. That outcome is possible only if the number of people who are unemployed also increased, resulting in a proportionally larger increase in the numerator in the unemployment equation relative to the denominator. In fact, the BLS estimated that the number of people unemployed increased by 344,000 from July to August 2022. Employment and unemployment both increasing during a month happens fairly often during an economic expansion as some people who had been out of the labor force—and, therefore, not counted by the BLS as being unemployed—begin to search for work during the month but don’t find jobs.

Source: U.S. Bureau of Labor Statistics, “The Employment Situation—August 2022,” bls.gov, September 2, 2022.

Why Might Good News for the Job Market Be Bad News for the Stock Market?

On Tuesday, August 30, 2022, the U.S. Bureau of Labor Statistics (BLS) released its Job Openings and Labor Turnover Survey (JOLTS) report for July 2022. The report indicated that the U.S. labor market remained very strong, even though, according to the Bureau of Economic Analysis (BEA), real gross domestic product (GDP) had declined during the first half of 2022. (In this blog post, we discuss the possibility that during this period the real GDP data may have been a misleading indicator of the actual state of the economy.)

As the following figure shows, the rate of job openings remained very high, even in comparison with the strong labor market of 2019 and early 2020 before the Covid-19 pandemic began disrupting the U.S. economy. The BLS defines a job opening as a full-time or part-time job that a firm is advertising and that will start within 30 days. The rate of job openings is the number of job openings divided by the number of job openings plus the number of employed workers, multiplied by 100.

In the following figure, we compare the total number of job openings to the total number of people unemployed. The figure shows that in July 2022 there were almost two jobs available for each person who was unemployed.

Typically, a strong job market with high rates of job openings indicates that firms are expanding and that they expect their profits to be increasing. As we discuss in Macroeconomics, Chapter 6, Section 6.2 (Microeconomics and Economics, Chapter 8, Section 8.2) the price of a stock is determined by investors’ expectations of the future profitability of the firm issuing the stock. So, we might have expected that on the day the BLS released the July JOLTS report containing good news about the labor market, the stock market indexes like the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite Index would rise. In fact, though the indexes fell, with the Dow Jones Industrial Average declining a substantial 300 points. As a column in the Wall Street Journal put it: “A surprisingly tight U.S. labor market is rotten news for stock investors.” Why did good news about the labor market could cause stock prices to decline? The answer is found in investors’ expectations of the effect the news would have on monetary policy.

In August 2022, Fed Chair Jerome Powell and the other members of the Federal Reserve Open Market Committee (FOMC) were in the process of tightening monetary policy to reduce the very high inflation rates the U.S. economy was experiencing. In July 2022, inflation as measured by the percentage change in the consumer price index (CPI) was 8.5 percent. Inflation as measured by the percentage change in the personal consumption expenditures (PCE) price index—which is the measure of inflation that the Fed uses when evaluating whether it is hitting its target of 2 percent annual inflation—was 6.3 percent. (For a discussion of the Fed’s choice of inflation measure, see the Apply the Concept “Should the Fed Worry about the Prices of Food and Gasoline,” in Macroeconomics, chapter 15, Section 15.5 and in Economics, Chapter 25, Section 25.5.)

To slow inflation, the FOMC was increasing its target for the federal funds rate—the interest rate that banks charge each other on overnight loans—which in turn was leading to increases in other interest rates, such as the interest rate on residential mortgage loans. Higher interest rates would slow increases in aggregate demand, thereby slowing price increases. How high would the FOMC increase its target for the federal funds rate? Fed Chair Powell had made clear that the FOMC would monitor economic data for indications that economic activity was slowing. Members of the FOMC were concerned that unless the inflation rate was brought down quickly, the U.S. economy might enter a wage-price spiral in which high inflation rates would lead workers to push for higher wages, which, in turn, would increase firms’ labor costs, leading them to raise prices further, in response to which workers would push for even higher wages, and so on. (We discuss the concept of a wage-price spiral in this earlier blog post.)

In this context, investors interpretated data showing unexpected strength in the economy—particularly in the labor market—as making it likely that the FOMC would need to make larger increases in its target for the federal fund rate. The higher interest rates go, the more likely that the U.S. economy will enter an economic recession. During recessions, as production, income, and employment decline, firms typically experience lower profits or even suffer losses. So, a good JOLTS report could send stock prices falling because news that the labor market was stronger than expected increased the likelihood that the FOMC’s actions would push the economy into a recession, reducing profits. Or as the Wall Street Journal column quoted earlier put it:

“So Tuesday’s [JOLTS] report was good news for workers, but not such good news for stock investors. It made another 0.75-percentage-point rate increase [in the target for the federal funds rate] from the Fed when policy makers meet next month seem increasingly likely, while also strengthening the case that the Fed will keep raising rates well into next year. Stocks sold off sharply following the report’s release.”

Sources: U.S. Bureau of Labor Statistics, “Job Openings and Labor Turnover–July 2022,” bls.gov, August 30, 2022; Justin Lahart, “Why Stocks Got Jolted,” Wall Street Journal, August 30, 2022; Jerome H. Powell, “Monetary Policy and Price Stability,” speech at “Reassessing Constraints on the Economy and Policy,” an economic policy symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 26, 2022; and Federal Reserve Bank of St. Louis.