In the world of finance, the non-farm payroll data is a closely watched economic indicator. It provides information about the number of paid workers in the U.S. economy, excluding those in farming, private households, nonprofits, and the military. A stronger-than-expected rise often signals a robust economy, while a weaker rise—or a fall—can signal economic troubles. The latest non-farm payroll data has sparked much debate about the direction of our economy. However, an argument could be made that we should be cautious about using such indicators as a gauge for financial policy. A closer examination of these numbers, particularly in light of recent pandemic-related events, may suggest that the Federal Reserve's employment-focused financial policy could inadvertently cause a deflationary event.
The Post-Pandemic Employment Landscape
In the wake of the COVID-19 pandemic, the employment landscape has seen significant and often unanticipated shifts. Many workers were suddenly removed from the workforce due to deaths, retirements, and changes in work-life priorities. As a result, many jobs were permanently lost or transformed, causing fluctuations in the employment data.
The current employment data includes the many new jobs created in response to the pandemic, as well as the jobs lost due to businesses closing or downsizing. It does not account for the number of potential workers who have decided not to return to work or those who have retired earlier than expected due to the pandemic. Therefore, the data does not present an accurate picture of the workforce's capacity or the true state of the economy.
The Pitfall of Employment-Centric Financial Policy
Given the distortions in employment data due to the pandemic, tying Federal financial policy too closely to this metric could lead to missteps. The Fed has long used employment data to steer its monetary policy, adhering to the belief that lower unemployment leads to higher inflation due to increased spending.
However, in the current situation, despite rising employment numbers, we could be heading towards deflation, not inflation. Why? Simply put, a significant portion of our workforce has been permanently reduced, and many others have been displaced due to pandemic-related circumstances. With fewer people working and fewer people looking for work, overall spending power in the economy may decrease.
To compound the issue, there has been a rise in savings and cautious spending due to the uncertainty of the pandemic, causing further reduction in spending. Thus, if the Fed continues to adhere to the conventional wisdom of equating employment with inflation, they may overcorrect, leading to deflation.
The Risk of Deflation
While deflation may sound appealing (who doesn't like lower prices?), it can be disastrous for the economy. When prices consistently drop, people may delay purchases in the expectation of lower prices in the future. This creates a downward spiral, with reduced spending leading to reduced production, leading to layoffs, and even lower spending. Additionally, deflation can increase the real burden of debt, as the value of money increases, but the amount owed remains the same. This can lead to financial distress and further economic slowdown.
Rethinking the Approach
The lessons of the past two years should lead us to reconsider how we interpret and react to employment data. Our policymakers need to acknowledge the distortions in the data caused by the pandemic and adjust their approach accordingly. The Fed should consider a wider array of indicators, including measures of spending, savings, and economic uncertainty, before making significant policy decisions.
We are in uncharted territory. It is imperative that our financial institutions adapt to the new landscape, with its unique challenges and opportunities, rather than adhering blindly to traditional policy approaches. Only then can we hope to steer our economy away from the risk of deflation and towards a more stable and prosperous future.