The improvement in the labor markets in 2014 far exceeded even the most optimistic forecasts. Job growth topped 3 million, with nearly two-thirds of all industries adding jobs, and the jobless rate fell by more than one percentage point to its lowest level since mid-2008. The broad and strong gains in job creation last year clearly indicate a significant change in the economic cycle. That’s because hiring reflects the needs and optimism of businesses about current and prospective economic conditions.

Consequently, policymakers need to adapt to the new economic climate. Their overly accommodative policy stance of the past several years has been aimed at generating “substantial” improvement in the labor market. That part of their mission now seems accomplished. In our view, the time has come for the Fed to begin the process of gradually normalizing official rates.

Payroll Employment Trends in 2014

Total payroll employment rose 3.116 million last year—the best annual gain since 1999 (Display 1).

Overall job gains were roughly one-third greater than what consensus and policymakers had expected at the outset of the year.

As impressive as the overall gains in payrolls were in 2014, so too were the gains across a number of industries. For example, the largest gains occurred in professional and business services (712,000) and education and healthcare (482,000). The construction sector added 338,000, its biggest gain since 2005, and the manufacturing sector added 222,000, its largest gain since 1997. That strong gain in manufacturing employment is notable, because it runs counter to the view that all our factory jobs are easily transferable to lower-cost countries.

If we look at the jobs growth tally of 85,000 for state and local government, it doesn’t appear very large on the surface. But it represents the first annual gain since 2008, and it offers strong evidence that the drag from cutbacks in the government sector has run its course.

Interestingly, despite the broad and strong gains in hiring in 2014, the need for workers at the end of the year was substantially greater than it was one year earlier. In fact, the number of job openings rose by 1.1 million, to 5.02 million at the end of 2014 (Display 2). That’s the largest annual gain on record and the second-highest level of job openings since the series was first constructed in 1999.

Labor Force Trends

Curiously, the strong payroll gains last year did not change the flow of workers into the workforce. The overall participation rate remained essentially unchanged over the course of the year. It stood at 62.8% in the fourth quarter of 2014, in comparison to 62.9% at the end of 2013. The failure of labor participation to increase concurrently with the strong job gains runs counter to the historical pattern. Typically, when job gains and opportunities are on the rise, the labor participation rate tends to increase. The fact that the participation rate did not increase in 2014 lends credence to the view that a significant part of the decline since the Great Recession is structural (i.e., a general aging of the workforce) and not cyclical (Display 3).

Monetary Policy Implications

Labor market trends have played a key, if not the main, role in policy deliberations over the past several years. In fact, in September 2012, former Fed Chair Ben Bernanke stated that the third quantitative easing program was directed solely at generating stronger and sustained gains in employment. In the 28 months since that September 2012 policy announcement, nearly 6.6 million payroll jobs have been created—roughly twice the 3.3 million that were created during the first 38 months of the recovery.

The scale and breadth of job gains is solidly robust. The current jobless rate of 5.7% is over 2.0 percentage points lower than it was in September 2012—and very close to policymakers’ longer-run projection of full employment. So it appears increasingly hard for the Fed to justify holding official rates at the zero bound.

As a result, we expect that policymakers will begin to telegraph that a mid-year (if not earlier) lift-off in official rates remains the policy script.

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By Joseph G. Carson, US Economist and Director, AB

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