US gained surprising number of jobs in February but wage growth was nearly flat

The economy added 678,000 jobs in February, an increase from the pandemic-affected January numbers and consistent with the rapid pace of job creation in the second half of 2021. The unemployment rate resumed its rapid decline, falling to 3.8 percent as labor force participation increased. Wage growth in February was, however, nearly flat after 10 straight months of strong nominal wage growth. It is possible this will turn out to reflect noisy data. Over the last three months (adjusted for industry composition), average hourly earnings have grown at a 4.2 percent at an annual rate, the slowest pace since March 2021.

Overall, the economy is still 3.5 million jobs and 1.4 million workers short relative to pre-pandemic projections (adjusted for lower than expected population growth), as labor supply continues to fall short of labor demand. The continued shift from a pandemic to a manageable endemic disease, along with monetary and fiscal policy that remains expansionary, should help continue to close the gap in 2022.

Payroll Employment Continues Its Steady Growth of about Half a Million Jobs Per Month

In contrast to expectations for a slight slowdown in job growth, payrolls rose 678,000 in February, as shown in figure 1. The February reading and additional upward revisions to payroll employment gains in December (+78,000) and January (+14,00) mean that employment growth has remained very strong.

The unemployment rate fell in February and is now only 0.3 percentage point higher than it was prior to the pandemic (figure 2a). The number of workers working part-time for economic reasons increased in February driving up a broader measure of labor market underutilization, U-6, which includes the involuntary unemployed. This is the first time U-6 has increased since April 2020.

Labor force participation remains low. As a result, even though the unemployment rate is nearly recovered, the employment rate for workers ages 25-54 remains 1.0 percentage point below its February 2020 level (figure 2b) after a 0.4 percentage point increase last month.

The Economy Still Remains Millions of Jobs Short of Its Pre-pandemic Trajectory as Labor Force Participation Lags

The labor market moved closer to normality in February, but the economy still remains 3.5 million jobs short of pre-pandemic projections adjusted for slower than expected population growth, as shown in figure 3 (or 4.2 million jobs short of the original pre-pandemic projection). We use the Congressional Budget Office's (CBO) January 2020 forecast for a projection of where jobs might plausibly have been absent the emergence of COVID-19 and the economic response it engendered. The civilian noninstitutional population ages 16 and older in January 2022 was 1.3 million (or 0.5 percent) lower than CBO had originally forecast, with excess mortality and reduced immigration both large factors.

Looking at the household survey's measure of the number of workers employed shows a considerably smaller gap than the employer survey's measure of the total number of jobs. In total, 1.4 million fewer people were employed in February 2022 than had been expected pre-COVID-19 (again adjusted for slower than expected population growth) as employment growth (the number of people surveyed who said they had jobs) outpaced job growth (the number of employers reporting a job) over the last year. Two of the reasons the employment shortfall is smaller than the jobs shortfall is that, since February 2020, multiple job holders have fallen by 0.6 million (this results in fewer jobs without any reduction in employment) and self-employment has risen by 0.2 million (this counts as employment but not as a job). Other issues, including different CBO forecast paths and other definitional and measurement differences, account for the remainder of the difference between the jobs and employment shortfalls.

The Labor Force is Returning but Still Well Below its Pre-COVID-19 Rates

The labor force remains substantially smaller than it was in February 2020, with the labor force participation rate down 1.1 percentage point since then. About a quarter of this decline, 0.3 percentage point, can be accounted for by the changing age-sex structure of the population. Because labor force participation tends to decrease at older ages, as the population ages, the overall labor force participation rate would be expected to fall even if the labor force participation rates for every age-sex group had been unchanged. Another 0.2 percentage point of the decline, or about a fifth, is due to some continued elevation of the unemployment rate. That leaves 0.6 percentage point, or more than half of the total decline in the labor force participation rate, unaccounted for by either changing demographics or elevated unemployment. The relative contributions of these three components are shown in figure 4.

Overall, of the 0.9 percentage point decline in the labor force participation rate that is not associated with the changing demographic structure of the workforce (both the “elevated unemployment” and “other” categories in figure 4), about twice as much of the decline has come from women as from men. Labor force participation rates are roughly as expected for younger workers, but there are similar contributions to declining participation from the 25-54 and 55+ age groups. Much of the difference between men and women is the result of a larger contribution from women aged 25-54, with the contributions for men and women similar among those 55 and older. (Note the breakdown of contributions can reflect volatile monthly data; the male-female contributions were roughly equal over the last few months but changed in February.)

Looking forward, developments in labor force participation and the unemployment rate will shape the trajectory of job growth going forward. The economy needs to create about 50,000 jobs a month over the next 10 months in order to keep the age-adjusted employment rate constant for the remainder of 2022. For the age-adjusted employment rate to return to what it was pre-pandemic would require about 418,000 jobs per month. To fully return to the pre-pandemic employment rate without adjusting for aging would require higher employment rates for similar-aged workers and about 542,000 jobs per month—slightly slower than the pace of job growth over the last three months.

Tight Labor Markets Have Contributed to a Pickup in Wages

Every indicator of labor market slack shows that labor markets are getting tighter. Different indicators still tell a somewhat different story about the degree of slack, but they are generally converging. The prime-age (25-54) employment rate shows slack in February modestly below its average from 2001 to 2018 (a period when the economy was, on average, below full employment). The unemployment rate was somewhat further below its average over that period, as was the ratio of unemployed to job openings, indicating meaningful labor market tightness. The quits rate (for December, the most recent month available) indicated an extremely tight labor market (figure 6).

In November, we investigated which of these measures was the best predictor of wage growth or inflation based on the experience prior to COVID-19 and concluded that all four measures behave in a broadly similar manner. However, with the unemployed-to-job openings ratio and quits rate most consistent with recent rapid wage and price growth through much of 2021, these two measures should get meaningful weight in assessing future wage and price developments.

The official average hourly earnings series for private-sector workers grew at a 4.6 percent annual rate over the last three months, a slowdown from recent months as average hourly earnings only grew $0.01 in February. The official average hourly earnings series is affected by the composition of the workforce, sometimes dramatically. In months when more lower-wage workers are hired back (for example, in the leisure and hospitality sectors), this compositional effect can artificially lower the reported growth of average hourly earnings. Figure 7 shows a chain-weighted alternative that accounts for the change in the industry-level composition from month-to-month and thus eliminates part, but not all, of the composition bias (it is impossible to do more with the data currently available). These numbers are generally similar to the Employment Cost Index, which adjusts for composition but is only available through December.

Prior to the pandemic, productivity was growing about 2 percent annually. If nominal wages continue to grow at a roughly 4 percent pace in 2022, their pace over the last three months and what employer surveys report for 2022, that would be consistent with 2 percent inflation (assuming no change in the labor share). If, as is more likely, wage growth is at or above its 5.5 percent pace last year, including upward pressure due to workers' demands for catch-up wage growth, staggered wage setting, and ever tighter labor markets, then inflation would be closer to 4 percent (assuming no change in the labor share). Nominal compensation growth and the trajectory of business mark-ups over cost are two key variables to watch in thinking about inflation in 2022.