The American economy has never had a soft landing. It is possible that we are about to experience one. If so, it will likely be because a massive increase in immigration has provided the economy with a soft cushion on which to land.
(Note: I will not address the question of whether this immigration is good in a general sense, but simply its impact on the macroeconomy.)
Some of the recent economic data is as bizarre as I’ve ever seen:
Nominal GDP up 5.2% year-on-year in second quarter, up 5.8% over 12 months
Real GDP in the second quarter increased by 2.8% year-on-year and 3.1% year-on-year
And yet the household survey suggests that fewer than 200,000 net new jobs were created in the past 12 months. This makes no sense. Real GDP data indicate that we are in a period of strong growth, and the household employment survey suggests that we are narrowly avoiding a recession. What is the truth?
The answer seems to be immigration. The household survey does not take into account the rise in immigration, many of whom are undocumented. But the government’s wage survey does take immigrants into account and shows a very large increase of 2.6 million (1.67%) in net new jobs over the past 12 months. This is about what one would expect from 3.1% growth in real GDP.
The wage survey has always been considered more accurate than the household survey in terms of short-term changes in employment, but I don’t recall ever seeing such a large gap. This gap coincides with a historically large increase in immigration.
Yesterday, Bill Dudley Bloomberg published an article suggesting that “the Fed should cut rates immediately.” Here are some of his arguments:
Slowing growth is reflected in declining employment. The household employment survey shows only 195,000 jobs created in the last 12 months. The job vacancy-to-unemployment ratio, at 1.2, has returned to pre-pandemic levels.
Most worryingly, the three-month average unemployment rate rose 0.43 percentage points from its lowest point in the previous 12 months, very close to the 0.5 threshold that, as identified by the Sahm rule, has consistently signaled a recession in the United States.
As I suggested, I think the household numbers are just wrong. I am a big believer in Sahm’s rule, though, and have actually developed a rougher version I have already discussed this idea in an earlier blog post. But in most cases, rising unemployment is triggered by a decline in labor demand. In this case, a large increase in labor supply seems to explain the rise in unemployment (at a rate that remains low in absolute terms). However, I would be concerned if unemployment reached 4.5%.
I have no opinion on where the Fed should set interest rates. But I do not see the need for the Fed to ease monetary policy, as nominal GDP growth remains excessive, even taking into account labor force growth. Monetary policy is therefore not currently too tight, at least based on recent macroeconomic data and implied expectations in various asset markets (notably stocks).
Please do not take this as a statement that I am opposed to lowering interest rates. It is likely (but not certain) that interest rates will have to fall at some point in the next 12 months, if only to keep the interest rate stable. monetary policy position roughly neutral. Again, interest rates are not monetary policy.
A Fed anti-inflation program during a period of low unemployment normally produces a recession. Generally, this is not the case. always This produces a recession in a few years. If it doesn’t happen this time, it will be our first soft landing.
(Note: The media often applies the term “soft landing” to a period like the mid-1990s, a period of rising and then falling interest rates without a recession. I use the term to refer to a prolonged period of cyclically low Unemployment without rising inflation. Let’s say at least three years. We’ve never had that, although without Covid we probably would have. We’re about 9 months away from declaring this to be America’s first soft landing. (Can Trump or Harris take credit for that?)
If we achieve this kind of outcome (which is not so uncommon in other countries), we have to ask ourselves how it happened. In my view, it would be due to a mixture of luck and skill. The skill would lie in the Fed’s ability to slow nominal GDP growth at a steady pace, without overshooting the limits in either direction. In retrospect, monetary policy clearly should have been tighter in 2022 and 2023, because there was a labor shortage. But it is hard to be too critical when inflation seems to be moving in the right direction, albeit too slowly. On the other hand, I am extremely critical of the Fed’s highly inflationary policy in 2021-22.
The lucky factor is the surge in immigration. Consider the 5.8% nominal GDP growth over the past year. Before the Covid-19 pandemic, the Fed estimated the economy’s trend growth rate at 1.8%. So one would expect that 5.8% nominal GDP growth would generate inflation of about 4%. If inflation were still this high, the Fed would be under pressure to slam on the brakes, risking a recession. Instead, 12-month PCE inflation has fallen to 2.6%, largely because of rapid real GDP growth, driven by rising employment. With inflation moving closer to the 2% target, the Fed feels it can afford to be patient.
I encourage people to be wary of pundits who warn against monetary tightening. Inflation and nominal GDP growth are still excessive. Anecdotal evidence about this or that sector of the economy does not tell the whole story: the overall economy is still booming and markets are optimistic. I do not see compelling evidence that money is too tight.
PS. Also be wary of people who claim that “inflation would only be X if we adjusted for Y.” Nominal GDP confirms that core inflation is still too high. Cherry pickers only want to discard misleading data that supports their argument, not data that undermines their argument.
