Janet Yellen, chair of the U.S. Federal Reserve, listens during a Senate Banking Committee hearing in Washington, D.C., U.S., on Thursday, Feb. 11, 2016.
Photograph by Bloomberg via Getty Images

Labor market is shrinking and that may pinch the Fed.

By Chris Matthews
May 6, 2016

Spring may have sprung, but somebody forgot to tell the job market.

Employers in the U.S. added 160,000 positions to their payrolls in April, according to the latest numbers from the Bureau of Labor Statistics, falling short of expectations of 200,00 new jobs. This headline figure helped depress stock markets, which were down slightly in early morning trading.

Optimists may wish to point to the fact that while new job growth was slower than expected, it’s still strong relative to what typical labor force growth needs to keep the the unemployment rate falling. In addition, wage growth was strong, with average hourly earnings rising 2.5% year over year.

But the unsugar-coated truth was that today’s report was pretty lousy, and it is in fact worse than you probably think.

That’s because what probably helped those wages grow is the fact that the labor force participation rate fell from March to April, partially wiping out the gains made since the beginning of this year.

The labor force participation rate, or the ratio of workers over 16 who are part of the labor force, is an important number because the more workers there are, the greater the potential size of the overall economy. The labor force participation rate has been on the decline since the 1990s, but the financial crisis accelerated this shrinkage, leaving economists to wonder how much the decline is the result of an aging population and how much is the result of a weak economy.

Recently, though, there has been some good news. The participation rate has been on the upswing. But if this April in fact marks the end of the rally in the labor force participation, then the Federal Reserve will have to think about raising interest rates sooner than it might otherwise. That’s because with the unemployment rate at the relatively low level of 5%, the only reason to argue against keeping interest rates low is that there is extra slack in the form of workers who want to work but have left the labor force because of poor economic conditions. If Fed Chair Yellen believes that these folks aren’t going to return to the labor market any time soon, it makes sense to raise rates now in order to head off inflation sparked by faster wage growth.

It’s important not to draw conclusions from just one month of data, but expect Yellen and her colleagues to look closely at labor force participation numbers in the months to come. Right now traders seem to be betting that the Fed would be crazy to raise rates now. But if Yellen & Co. come to the conclusion that the participation rate is as high as it’s going to get, the market might be in for a shock.

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