Too many people are still unemployed. Photographer: Craig Warga/Bloomberg
Too many people are still unemployed. Photographer: Craig Warga/Bloomberg

(Corrects seventh paragraph in article published June 6 to indicate that employment peaked in January 2008.)

Today’s highly anticipated U.S. jobs report sheds light on a crucial question for the economy: How much more can the Federal Reserve do to stimulate growth and push down unemployment before it runs into undesirable inflationary consequences?

Economists have long been engaged in a discussion about the nature of unemployment in the U.S.: Is it more short-term and cyclical, or is it more structural and long-term? In the former case, accelerating growth can bring the unemployment rate back down to where it was before the crisis. In the latter case, the "natural rate" of unemployment would be higher, impairing the economy's ability to create jobs and grow without stoking inflation beyond the asset markets.

Until recently, the debate was largely academic: Given the depth of the economic downturn, everybody recognized that there were lots of jobs to recover before unemployment fell anywhere near its natural rate. Moreover, with political polarization on Capitol Hill undermining a comprehensive policy response, there wasn’t much interest in figuring out how the natural rate itself could be improved.

Now, though, the question is gaining urgency. The widely followed U-3 unemployment rate has fallen to 6.3 percent, down from a 2009 peak of 10 percent and approaching -- albeit frustratingly slowly -- the pre-crisis low of 4.4 percent. Yet economists have yet to agree on a threshold beyond which inflation (outside the asset markets) might become a problem. Nor have they converged on a narrative about an important determinant of job creation -- the level and composition of economic growth.

One group is quick to point to bad weather as the major cause for slow growth and sluggish job creation this year. They predict a sharp and relatively quick growth rebound, supported by evidence that underlying financial conditions are gradually improving. Another group is a lot more cautious. They believe that the U.S. faces secular headwinds that are consequential and durable, especially if Congress continues to dither in performing its economic governance responsibilities.

Increasingly, neither policy makers nor markets will have the luxury of pursuing multiple narratives. As more jobs are created, and particularly if the participation rate remains stuck at its multidecade low, the Federal Reserve and investors will have to come to a more definitive view of the relative weight of structural and secular headwinds to America’s labor market recovery. It's particularly important for the Fed in the months to come, given the country’s heavy reliance on monetary policy. It will be one of the important determinants of whether history books end up characterizing the current period as a handoff to economic liftoff and durable market prosperity, or the preamble to a policy mistake and a market accident.

So, what does today’s jobs report tell us? At first blush, it provides some support for both views.

The cyclical camp will take comfort in the solid pace of monthly job creation. At 217,000, May’s increase in nonfarm payrolls is above the prior two-month average of just under 200,000. It takes the total number of employed back above the prior peak of 138 million, attained in January 2008.

The structural camp will focus on the persistence of long-term unemployment (still stuck above 4 million), the failure of the labor-force participation rate to rebound from unusually low levels, and the persistent very high unemployment among less educated workers.

Still, the report does provide some useful insights for the Fed, and for market participants who have been trading on the back of Fed policy.

Once again, and despite the solid job creation, earnings growth remains anemic. As such, it is hard to make a strong case that the labor market is getting too tight overall. There are more jobs to be gained before the natural rate becomes a binding constraint, and before the current monetary policy stance goes from being economically enabling to disruptive. This validates the Fed's pivot from focusing on a single job metric (the U-3 measure of unemployment) to a more holistic assessment of labor market conditions.

While the period of easy gains in reducing excessive unemployment is behind us, there is still scope for addressing the cyclical component of a problem that is central to U.S. economic prosperity and a less unequal society. In a perfect world, our politicians would use this window to work on the other, more protracted component of the unemployment problem -- that of long-term unemployment. Unfortunately, there is little to suggest that this will happen anytime soon.

To contact the writer of this article: Mohamed A. El-Erian at M.El-Erian@bloomberg.net.

To contact the editor responsible for this article: Mark Whitehouse at mwhitehouse1@bloomberg.net.