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Economic Report: Here’s why strong U.S. job gains might lead to recession

Normally the U.S. adding 200,000 new jobs a month would be cause for celebration, but now the speedy pace of hiring might actually raise the odds of recession.

Here’s what is going on. Strong employment gains are exacerbating an acute labor market shortage. The result is a rapid rise in wages that threatens to prolong the worst U.S. inflation in four decades.

To bring inflation down, the Federal Reserve is swiftly raising interest rates to slow the economy. Higher borrowing costs depress consumer spending and business investment and, just as important, reduce the demand for labor.

Yet unless the labor market cools off considerably faster, the Fed is likely to raise interest rates even higher than expected and potentially trigger a recession. Indeed, most Wall Street
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economists predict a recession in 2023.

Until not long ago, the Fed was banking on an increase in the number of people looking for work to ease the labor shortage. The expectation was that many workers who dropped out of the labor force during the pandemic would return

For while that’s exactly what happened, but the size of the labor force has actually shrunk since August. Now it’s slightly below pre-pandemic levels again almost three years after the onset of the coronavirus.

There were 164.5 million people in the labor force in November. Had the pandemic never happened, the labor force likely would have added another 3.6 million people from 2020 through 2022, based the average annual increase from 2012 to 2019.

Where have all these people gone?

Federal Reserve Chairman Jerome Powell on Wednesday estimated about 2 million people retired and haven’t come back. Some are still worried about the coronavirus, he suggested, while others were able to retire more comfortably because of a big rebound in the stock market.

The remaining 1.5 million shortfall in workers, Powell said, was likely tied to the high number of Americans who died from the coronavirus as well as a net decline in immigration.

The lack of workers has become a huge problem for businesses. Many could not hire enough workers after the U.S. economy recovered and demand for goods and services exploded.

Companies have been forced to pay sharply higher wages to attract and retain employees amid fierce competition for labor. Hourly wages have risen 5.1% in the past year, about twice as fast as the average annual gain in the decade before the pandemic.

“Low participation in the face of strong demand will continue to fuel wage growth pressures,” said Julia Pollak, chief economist at ZipRecruiter.

Powell has insisted he’s not against higher wages for employees. But he’s stressed that wage growth much higher than 2% to 3% is likely to worsen inflation since it’s the biggest single expense for many businesses.

The Fed is not going to see much or any slowdown in wages, however, if the economy keeps adding 200,000 new jobs a month. That’s far more than the economy needs to soak up all the new people entering the labor force.

Powell suggested in his speech in Washington on Wednesday that the economy only needs to add around 100,000 new jobs a month to keep up with labor-force growth. Any more than that just exacerbates the labor shortage — and makes a recession more likely.

“The Fed needs the labor market to cool more quickly to engineer a soft landing,” said Ryan Sweet, chief economist at Oxford Economics.

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