The immigration pillow

The US economy has never had a soft landing. It is possible that we are about to have one. If so, it will likely be due to the fact that a massive surge in immigration has provided a big soft pillow for the economy to land on.

[Note: I will not address the question of whether this immigration is good in any overall sense, just the impact on the macroeconomy.]

Some of the recent economic data is about as bizarre as I’ve ever seen:

Q2 NGDP up 5.2% annual rate, 5.8% over 12 months
Q2 RGDP up 2.8% annual rate, 3.1% over 12 months

And yet the household survey suggests that fewer that 200,000 net new jobs have been created over the past 12 months. That makes no sense. The real GDP data says we are in a major boom, and the household survey of employment suggests we are barely avoiding a recession. What gives?

The answer seems to be immigration. The household survey is not picking up the surge in immigration, many of whom are undocumented. But the government’s payroll survey of employment is picking up the immigrants, and shows a very large 2.6 million increase (1.67%) in net new jobs over the past 12 months. That data is roughly what you’d expect with the 3.1% RGDP growth.

The payroll survey has always been viewed as more accurate than the household survey for short run changes in employment, but I don’t ever recall seeing such a huge discrepancy. This discrepancy coincides with a historically large surge in immigration.

Yesterday, Bill Dudley had a Bloomberg piece suggesting that “The Fed Needs To Cut Rates Now”.  Here are a few of his arguments:

Slower growth, in turn, means fewer jobs. The household employment survey shows just 195,000 added over the past 12 months. The ratio of unfilled jobs to unemployed workers, at 1.2, is back where it was before the pandemic.

Most troubling, the three-month average unemployment rate is up 0.43 percentage point from its low point in the prior 12 months — very close to the 0.5 threshold that, as identified by the Sahm Rule, has invariably signaled a US recession.

As I suggested, I think the household figures are simply wrong.  I am a big fan of Sahm’s Rule, however, and indeed once developed a cruder version of this idea in an old blog post.  But in most cases, rising unemployment is triggered by a fall in labor demand.  In this case, a huge surge in labor supply seems to explain the uptick in unemployment (to a rate that is still low in absolute terms.)  Nonetheless, I would be concerned if unemployment rose up to 4.5%.

I do not offer opinions on where the Fed should set interest rates.  But I see no need for the Fed to ease monetary policy, as NGDP growth is still excessive, even accounting for labor force growth.  So monetary policy is not currently too tight, at least based on recent macro data and the implied predictions in various asset markets (especially stocks.)

Please do not take this as a statement that I am opposed to lower interest rates.  It is likely (but not certain) that interest rates will have to fall at some point over the next 12 months, if only to keep the stance of monetary policy roughly neutral.  Again, interest rates are not monetary policy.

A Fed anti-inflation program during a period of low unemployment normally produces a recession.  Not usually, it always produces a recession within 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 something like the mid-1990s, a period of rising and then falling interest rates with no recession.  I am using the term for a sustained period of cyclically low unemployment without rising inflation.  Say at least three years.  We’ve never had that, although without Covid we probably would have.  We are about 9 months away from me declaring this to be America’s first soft landing.  (Will Trump or Harris be able to take credit?)]

If we do achieve this sort of result (which is not that uncommon in other countries), we need to consider how it happened.  In my view, it would be due to a mix of luck and skill.  The skill would be the Fed’s ability to slow NGDP growth at a steady rate, without overshooting in either direction.  In retrospect, money clearly should have been tighter in 2022 and 2023, as there was an outright labor shortage.  But it’s hard to be too critical when they seem to have inflation moving in the right direction, albeit too slowly.  On the other hand, I am extremely critical of the Fed’s highly inflationary policy of 2021-22.

The luck part is the surge in immigration.  Consider the 5.8% NGDP growth over the past year.  Prior to Covid, the Fed estimated the economy’s trend rate of growth at 1.8%.  Thus you’d expect 5.8% NGDP growth to deliver roughly 4% inflation.  If inflation were still that high, the Fed would be under pressure to slam on the breaks, risking recession.  Instead, 12-month PCE inflation is down to 2.6%, mostly due to the fast growth in RGDP, caused by the surge in employment.  With inflation getting close to the 2% target, the Fed believes it can afford to be patient.

I would encourage people to be wary of pundits warning that money is too tight.  Both inflation and NGDP growth are still excessive.  Anecdotes about this or that sector of the economy don’t tell the whole story—the overall economy is still booming and the markets are optimistic.  I don’t see persuasive evidence that money is too tight.

PS.  Also be skeptical of people who say “Inflation would be only X is we adjusted for Y”.  NGDP confirms that underlying inflation is still too high.  Cherry-pickers want to only throw out the misleading data points that help their argument, not the misleading data points that hurt their argument.

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