Why the Fed should ignore full employment


One of the biggest challenges that the United States and many other developed countries are facing is the lack of productivity growth. During the recovery following the financial crisis of 2008-2009, Gross Domestic Product (GDP) was able to grow but it wasn’t driven by rising workers productivity. The lack of an increase in output per worker, or the ‘productivity puzzle’ seems to hamper economic growth, despite low unemployment rates. Is the Federal Reserve pursuing the wrong mandate?

Long term trend

Since the Industrial Revolution, rising productivity of workers has historically been an important factor in economic growth. For example during the golden years of 1948 to roughly 1973, US productivity rose at rates of around 3%. Elsewhere in the developed world, these rates were witnessed as well. Take for example Germany’s “Wirtschaftswunder” during that period. But during the last decade, productivity gains were very poor, despite the benefits of the digital revolution. The problem with the productivity puzzle is that wage growth stays very moderate. The high productivity in the past was a major contributor to higher income and wealth for the working middle class. A large part of the high level of welfare was built on productivity growth. For future generations, this is clearly at stake with the current productivity puzzle.

Phillips curve

The Federal Reserve is a protagonist of the Phillips Curve while setting its policies. The Philips Curve states an inverse relationship between unemployment rates and inflation. That means when unemployment drops and the labor market is approaching full employment, wage growth should arise and cause inflation to increase. The current state of the economy shows that this theory is not a proper explanation of economic reality, since we have nearly full employment in the US and still very sluggish (if any…) wage growth. The lack of wage growth means that the labor factor holds an advantage to investments in capital goods, despite low interest rates which make investments relatively cheap. On the contrary, since that labor is preferable, low interest rates are not used for investments but for shareholder presents such as balance optimization for higher dividends or buyback programs.

The lack of wage growth is however a major concern. When workers don’t see their paychecks rise, they won’t up their consumption. The economy won’t see any additional demand. Investments are lacking as well, so where should economic growth come from? Making investments more expensive by increasing interest rates, which the Federal Reserve is considering, would be a major mistake. It may be more wise to postpone this decision and wait for significant wage pressure and therefore making investments in capital goods more interesting. Ignore ‘full employment’ for now and stick to the inflation mandate.

Too much reliance on the Fed

However, we may be well across the point where we have to much confidence in Central Banks. Cheap and abundant money, which we had during the recent years is not a panacea. It is time for the government to step up. Make that investments are happening. Companies should have faith in the future and that economic decisions will lead to higher earnings. Management should have reason not to continue their shareholder-pleasing strategies, but instead should have incentives to invest in research and development in order to find new technologies. The government should facilitate this type of environment by a wide range of policy measures. Removing red tapes, making buybacks less interesting compared to R&D investments, incentives for fresh investments, smarter taxing so that the working middle class can spend more etc. We can’t rely much longer on the safety cushion of the Federal Reserve. Normalization is needed. Because if there are new economic setbacks or a recession, what additional unconventional measures are left? There might be simply not enough firepower available to battle a new crisis…


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