The Laws of Economics Broke Before The Labor Market Did

Key Takeaways

Forecasters expected mass layoffs in 2023 that never arrived.
Consumer spending accelerated, encouraging employers to keep hiring, which meant more people collected paychecks, which fueled more consumer spending, in what one economist called a “virtuous circle.”
Economists had expected the Federal Reserve’s campaign of anti-inflation interest rate hikes to interrupt that cycle but it hasn’t, at least not yet.

In 2023, the well-known rules of economics dictated that hundreds of thousands of people should lose their jobs.

But instead of cracking, the labor market continued to chug along. The mass layoffs never arrived. 

“It defied expectations,” said Nick Bunker, director of the hiring lab research group at job website Indeed. “I think lots of people were very pessimistic about the outlook for the U.S. labor market, but it surprised people in many ways.”

This time last year, most economists looked at the U.S. economy and saw a labor market that was overheated and destined to go down in flames. Workers were in too high demand and wages were increasing too fast, which risked stoking out-of-control inflation through a wage-price spiral

The Federal Reserve’s response—a rapid rise in interest rates—was bound to prompt businesses to cut back their payrolls to weather a possible recession.

The median prediction of economists polled by the Philadelphia Fed in late 2022 was for the unemployment rate to rise to 4.4%, from the near-record low of 3.3% at the time. Some were even more pessimistic. Economists at Fannie Mae predicted it would be 5.7% in the fourth quarter of 2023—a rate that would mean millions of people losing their jobs.

Instead, employers have consistently added jobs all year, albeit at a slower pace than last year, and the unemployment rate has only risen to 3.7%—not too far above the 50-year low of 3.4% seen in April. What’s more, the increase in the unemployment rate comes not from a wave of layoffs, but partly from the fact that more people have started looking for work. (The unemployment rate is calculated as the percentage of job-seekers who haven’t found work.)

One of the experts caught off guard was Mark Zandi, chief economist at Moody’s Analytics. Zandi had been unusually optimistic in his projections last year in that he did not predict a recession, but still hadn’t expected the job market to lose as little steam as it did.

“Seldom in history has it been in better shape, and that is no hyperbole,” Zandi wrote in a commentary this week. 

So, what gives? After all, the pessimists had good reasons to expect job losses, mainly the Federal Reserve’s campaign of anti-inflation interest rate hikes.

Starting in March 2022, the Federal Reserve raised its benchmark interest rate 11 times, reaching a 22-year high in July, and held it steady there ever since. Nearly everyone expected this war on inflation to cause collateral damage to the labor market. After all, that’s what has happened most times the Fed has raised interest rates in the past, from the 1970s through the Great Recession of the early 2000s.

So, why hasn’t it?

One possible explanation is that demand for workers has fallen considerably since the Fed started raising rates, just like the economic theory would dictate, but that the starting point was such a high level, that it hasn’t fallen far enough yet for employers to begin laying off their workers en masse. As of October, there were 8.7 million job openings, a drop of 27% from the peak in March 2022. Despite the drop, however, there are still 1.3 jobs for every unemployed worker, far above pre-pandemic levels.

Demand for workers is still high because consumers still have money—or credit—to spend, and are willing to spend it, Bunker said. Data on consumer spending has also defied expectations for a slowdown.

“Consumers are still demanding lots of things. So therefore, there’s opportunity to keep hiring people to provide those goods or services,” he said.

The reverse is also true, Bunker said—consumers have money to spend because they still have jobs and are getting decent raises. 

“I think that’s part of the virtuous cycle we’re in now,” he said. “It got kick-started in 2021.” 

The Fed’s interest rate hikes may yet bite the labor market. After all, monetary policy famously “works with long and variable lags,” as officials at the Fed are fond of saying, paraphrasing economist Milton Friedman. In some past recessions, waves of layoffs came years after the fed funds rate reached its peak.

All signs point to the labor market continuing to cool off gradually without crashing, at least for the time being, Bunker said. 

“In the very short term, things still look pretty good,” he said.

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