Since becoming Minneapolis Fed president at the start of 2016, Neel Kashkari has repeatedly expressed a reluctance to raise interest rates. And the reason he cited most was that the U.S. job market wasn't as strong as the steadily falling unemployment rate made it seem.
On Friday, a week after the nation's unemployment rate reached its lowest level in 50 years, Kashkari said the job market is still not as tight as the rate indicates. The central bank should look at wages instead, he said.
"Historically we believe, and the evidence shows, the unemployment rate was a pretty good proxy for measuring slack in the labor market," Kashkari said. "But it has really failed us in this recovery and it continues to send off faulty readings."
Many economists and observers think the low rate means the U.S. is at or near full employment, a moment when the Federal Reserve would typically begin to raise interest rates to prevent overheating and inflation.
But in an essay published by the Wall Street Journal and an interview with the Star Tribune, Kashkari said other data continue to show the labor market still has distance to go before reaching full employment.
For instance, there are still people on the sidelines who are emerging to take jobs as wages rise. If the participation rate of working-age workers, defined as those ages 25-54, were as strong today as it were in 2000, another 2.3 million Americans would be working, he said.
Economists debate reasons for the decline of workforce participation in the U.S. Theories vary — the effects of automation, the opioid crisis, technical-skills gap are considered — but these ideas don't satisfy Kashkari. "There's no good explanation for why it should be lower," he said.
And if it shouldn't be lower, he said, more people will continue to take jobs as wages rise. He noted that the April jobs report showed that more than 70% of people who were hired indicated that they weren't looking for jobs in March.
As the leader of a regional Fed bank, Kashkari participates in the rate-setting meetings that happen every six weeks at the Federal Reserve in Washington. However, voting is rotated among the regional presidents; Kashkari had voting rights in 2017 and will get them again next year. He voted against the three rate hikes that happened in 2017.
Kashkari has also repeatedly observed that inflation, the other factor the Fed is mandated to consider in setting interest rates, has not reached the targeted level of 2% that would trigger rate hikes. But it's his skepticism about the strengthening labor force that runs most contrary to conventional economic views.
Since his start at the Minneapolis Fed, Kashkari has traveled the six states — from Montana to Michigan — in which it oversees banking and asked business executives for their read on the economy. He frequently heard complaints about worker shortages but, when he asked if they were raising wages, executives said they didn't want to do that.
After hearing that over and over, Kashkari said, "I've basically concluded that talking to businesses to get a sense of slack in the labor market is almost useless."
He realized business owners and executives look at wages differently from other costs. Partly that's because when wages rise, they rise permanently since it's virtually impossible for an employer to cut workers' pay. But Kashkari said he also believes emotions are involved.
"If the price of steel or oil or corn, or any input into their business, goes up, they say 'Oh well the market price went up, I have to pay it.' But if they're trying to hire workers, they only want to pay wages that they're used to paying. And if the workers are not available, they say 'Oh my gosh there's a worker shortage,' " Kashkari said. "No, the price just went up."
In his essay, Kashkari explains why the Fed's rate-setting policymakers and other economic observers should pay more attention to price signals for labor rather than the unemployment rate.
Wage growth is about 3% now in the U.S. To be in balance with today's productivity growth rate of 1.5% and the Fed's targeted inflation rate of 2%, wages should be growing at 3.5%, Kashkari said.
"We are seeing wage growth pick up. Clearly the labor market is tightening," he said. "But is the market really tight yet? The answer is no."
For the Fed, he said, that means it's not time to raise interest rates.
"I'm not dogmatic about this. If wage growth picks up a lot, I would say 'Hey, it looks like we're there,' " Kashkari said. "But until that happens, we've got to let this economy continue to strengthen."