What the JOLTs Report Tells Us About the Stimulus
The discussion around fiscal stimulus has largely centered around estimates of potential output. The December JOLTs report provides an opportunity for an alternative take of the debate. The underlying strength in the labor market evident in the JOLTs numbers suggests the stimulus is designed for an economy very much unlike what we are currently experiencing. There is no point in debating the wisdom of the stimulus – it’s a runaway train. We should instead focus on the potential consequences.
Job openings and quits both rose in December:
The V-shaped recoveries in openings and quits stand in stark contrast to the labor market dynamics of the last recession. Supply side impacts, largely the inability to safely produce goods and services in leisure and hospitality and other sectors requiring close contact, dominate the dynamics of this cycle whereas a sustained demand shock dominated the last. After the 2007-09 recession, the job market recovery took years. Now, the levels of openings and quits suggest that underlying labor demand already looks like it did in 2017-2018. It could quickly move to the 2018-19 range on the basis of reopeing alone. And that’s before the fiscal stimulus of December or the round currently being debated in Congress.
Another way to think about the situation is in terms of the Beveridge Curve:
In the initial stage of the pandemic, the Beveridge curve points shifted far to the right as unemployment rose more quickly than job openings fell. The initial concern was that the economy would follow path B to the place of the last recession with low levels of job openings and high unemployment consistent with a severe demand shock. The reality has been instead path A with the economy quickly reverting to a pre-pandemic labor market. Fiscal policy in both magnitude and targeting is being designed though as if the economy was on path B.
I am not going to dive into a debate on the wisdom of designing fiscal policy for path B instead of path A. That train has left the station. The political and economic scars of the last cycle run deep and there isn’t much appetite to risk a repeat episode. Moreover, years of inflation fears having not been realized has left stimulus detractors with little credibility to influence the discussion. With a flat Phillips curve, the risk of doing too much is perceived as much less than the risk of doing too little. In addition, Democrats hold only a razor-thin margin in the Senate; they might not get another bite at the apple in the future.
If in fact upcoming fiscal stimulus overheats the economy, what form does that overheating take? For most, the belief is that overheating takes the form of inflation. More specifically, what I would call “interesting” inflation, something sustainable in excess of 2.5% and poised to rise further (even this though is a low bar relative to even the early 1990s). In order to be sustainable, we need to see matching behavior in wage inflation. That dynamic has not proven easy to replicate in recent years and I would be wary of assuming it occurs soon even under the assumption of sustained and substantial fiscal stimulus. I don’t think we understand exactly what will flip the switch on inflation dynamics and consequently we should be wary in automatically assuming that “overheating” the economy in 2021 flips that switch.
Given the sticky inflation dynamics, overheating will at least partly take the form of asset price appreciation. This has been a repeated theme of mine. If the federal government keeps pushing money into an economy that is not yet fully reopened, savings will continue to grow. The more it grows I suspect the smaller proportion of it will eventually find its way into spending. There are only so many vacations we will take to compensate for travel foregone during the pandemic. It will instead become a level step rise in household savings and get pushed into financial assets.
The Fed will be navigating some interesting waters in the months ahead. If the Fed intends to build credibility in its new policy framework, it needs to continuously reinforce its messaging that rate hikes are off the table until actual inflation is at or modestly exceeds 2% on a sustained basis. They need to stick with this rhetoric in the near term even if inflation exceeds 2% on a temporary basis as they think is likely to happen. They also need to stick to this rhetoric even in the face of asset price appreciation. And also as fiscal stimulus lifts growth prospects.
Federal Reserve Chair Jerome Powell will continue championing the new policy framework. That means sticking to the stript about “sustained progress” for asset purchases and actual inflation for rate hikes. He will continue to maintain this story even if fiscal stimulus drives forecast improvements. Unfortunately, it strikes me that there is an inherit disconnect in the Fed’s communication strategy. The SEP and associated dot-plot are forecasts of policy while policy itself is outcome-based now. One potential tension is that improving economic forecasts induces one or more FOMC participants to push up 2022 or 2023 dots. Plus, we have the 2024 dots to look forward to. If dots do start to push upwards, expect Powell to downplay the dots and emphasize that the initiation of rate hikes will be on the basis of realized inflation not the forecast.
Bottom Line: Given that incoming fiscal stimulus looks more designed for a 2007-09 recession than the current cycle, what am I watching for? First, signs that the inflation/wage dynamic flips into something that would be interesting from an inflation perspective. I don’t expect that anytime soon. Second, how much fiscal stimulus gets pushed in to savings and the subsequent impact on asset prices. Third, the Fed’s reaction to improving economic forecasts and how those improvements become realized in the SEP. Fourth, the Fed’s commitment to its new strategy and in particular the emphasis on realized outcomes. That shouldn’t change anytime soon.