A Healthy Economy Is the Best Medicine for the Labor Market

In large part, the conditions that characterize a generally healthy economy are the same conditions that will encourage increased hiring.

The second half of 2013 brought promising signs on both fronts. Overall economic growth, as measured by the gross domestic product (GDP), improved significantly in the third and fourth quarters compared to the previous three quarters. In the first half of 2013, real GDP—adjusted for inflation—expanded at a rate of 1.8 percent annualized, slower than the average during the recovery from the Great Recession. Growth then accelerated to an estimated annual pace of 3.3 percent in the second half of the year.

Some of the strength in the second half resulted from the buildup of inventory, which can’t go on indefinitely. But the economy also exhibited renewed strength in consumer spending, business spending on equipment, and exports—which suggests rising confidence about future prospects for the economy. Anecdotal evidence from business contacts in the Southeast also indicated solid confidence.

Brighter sentiment and stronger consumer spending bode well for the labor market. What’s more, these two factors—business confidence and consumption—feed off each other. If people running firms believe demand for their products and services is sufficiently strong, then they are more likely to invest in people through hiring. Likewise, better job prospects, along with rising stock and home prices, should fuel more consumer spending.

As 2013 ended, it was premature to declare the start of such a virtuous cycle. Moreover, it is almost always difficult to discern the precise state of the economy, as incoming data are rarely unambiguously positive or negative. For example, because of declining labor force participation, the unemployment rate has been particularly difficult to read during the recovery. And month-to-month reports of employment growth can fluctuate dramatically. In such circumstances, measures of inflation can be especially helpful. In general, weak overall demand is associated with weak prices. Therefore, watching inflation and wage growth can help gauge whether the economy is gathering the underlying strength it needs to quicken the healing of the labor market.

Economic performance in the latter part of 2013 suggested glad tidings. If that pace of growth persists—thus signaling the long-awaited acceleration in the economic expansion—then better labor market conditions should follow.