Two key components have shifted the economic paradigm

Globalization and demographics have influenced economic conditions for centuries, but their economic implications have changed dramatically. This has serious potential consequences for monetary policy models based on historical observation.

The job market in the United States is currently very strong — possibly the strongest it’s been in generations. With such widespread conviction in employment conditions, the Labor Department’s monthly Jobs Report has become less about jobs and more about inflation.

{mosads}Today’s employment report for September came in a bit light on job creation (134,000 new jobs versus 185,000 expected), but the sharp upward revision to the prior two months (87,000) made up the shortfall.

September job growth was also likely constrained by Hurricane Florence. Regardless, three and six-month payroll growth averages stand at solid levels of 190,000 and 203,000, respectively.

Average hourly earnings and its implications for future inflation was expected to be the star of today’s release. Financial markets and policymakers have long been watching for signs that the ever-tightening labor market is producing stronger wage pressures that will eventually boost broader inflation.

As hourly earnings in September slipped to a year-over-year rate of 2.8 percent from August’s 2.9 percent — partially due to technical reasons — those fears were once again eased.

If we take a step back and look at the broader relationship between labor market tightness, wage gains, and inflation, however, we see a very interesting picture. Although the U.S. unemployment rate first slipped under the 5 percent threshold over two-and-a-half years ago, average hourly earnings have barely budged.

In January 2016, average hourly earnings were 2.6 percent higher. In January of this year, investors were startled when hourly earnings came in hotter than expected, but the year-ago rate was still 2.8 percent. Little has changed.

In September, although the unemployment rate dropped again to 3.7 percent, hourly earnings were still just 2.8 percent higher.

We have confidence that an ever-tightening labor market will eventually put upward pressure on labor costs. But this remarkable period of non-inflationary unemployment declines should be telling us something — and its message could have considerable implications for Federal Reserve policy and the prospects of an over-tightening induced economic downturn.  

Central bank officials rely on economic models and personal judgment. Economic models, however, are based on historical observation. Significant changes in two primary economic fundamentals over a relatively short period (by economic standards) could result in unintended outcomes should policy adhere too strictly to the historical models.

Globalization and demographics have influenced economic conditions for centuries. But the manner in which they are influencing economic activity today has changed dramatically.

Globalization, the potential to source or sell goods and services nearly anywhere in the world almost instantly, has exploded amid the rapid adoption of the internet and sometimes we forget that the internet, in its high functioning state, has only been in existence for about 20 years.

The internet has been jet fuel for what was already a strong expansion of global trade. The term globalization has come to define this phenomenon and has been equally utilized when describing the repercussions for wages and consumer prices.

High-wage countries have found themselves competing with low-wage markets with increasing frequency, and despite our near-term trade turmoil, this is unlikely to change. Globalization has had a pronounced influence in containing both wages (in high-cost markets) and consumer prices like never before.

Additionally, the world’s demographic situation is changing. Around the world, developed counties are seeing slower population growth, and their populations are aging. Consequently, labor-force growth has slowed, which directly impedes an economy’s potential rate of expansion absent offsetting productivity gains.    

The extreme example of this demographic shift’s impact on economic growth and inflation is Japan. Since 2011, Japan’s population growth has not been slowing, it’s been in absolute decline, according to the country’s government statistics agency.

Additionally, the average age of its population, with a record 27.7 percent above 65 in 2017, is the highest in the world. Fewer people and fewer of working age, means fewer people to produce goods and services, thus contributing to economic output.

As a result, Japan struggles to generate any sustainable economic expansion. And more importantly, it still fights ardently against deflationary forces despite a recent unemployment rate of 2.4 percent. The U.S. is by no means likely to experience a Japan-style economic situation anytime soon, but the influences are tangible nonetheless.

Federal Reserve officials have not gotten enough credit for getting it right over the last decade. Pundits will always second-guess with the aid of hindsight, but the fact that real economic growth has been remarkably steady, unemployment has progressively declined, and even ordinarily skittish financial markets have been relatively calm, deserves appreciation.  

Due praise aside, there is still risk that the changing dynamics of these very powerful fundamental forces could lead to unexpected outcomes as the Fed continues to raise rates. After all, the Phillips Curve, which has long described the very intuitive relationship between unemployment and inflation, has been mysteriously missing in action for years.

Russell Price is the chief economist at Ameriprise Financial and member of the firm’s Global Asset Allocation Committee.