Will the unemployment rate drop faster than we expect it to?

The unemployment rate is one of the most commonly used indicators of economic performance. When the economy is expanding, companies hire more workers and the rate tends to drop. However, the US has recently been adding jobs at a fairly robust clip, but the unemployment rate has remained stubbornly high–today it stands at about 8.5%, about 3 percentage points higher than it “should” be.

One of the reasons that unemployment has not dropped as quickly as we might expect, given job growth, is that the so-called “discouraged workers” are coming back into the labor force. 

A definition is in order. The unemployment rate is the ratio of the unemployed to the labor force, with the labor force consisting of the employed and unemployed. Officially, to be considered unemployed, one has to be actively searching for a job.

However, when times are tough in the labor market, some unemployed people stop looking for work altogether. In essence, they have dropped out of the labor force. And when an unemployed worker drops out of the labor force the unemployment rate actually declines. While it seems counterintuitive, it’s just a definition with a bit of math.

Now, when the economy grows again, like it is now, discouraged workers tend to start looking for work again, rejoining the labor force. If they come back into the labor force without a job, the unemployment rate goes up. And even if they come back in with a job, the unemployment rate does not drop by as much as it would have if that person had never stopped looking for work. Once again, math.

The above story has been told to explain why unemployment is so damn high. Yet there is something else strange going on that has me wondering if the unemployment rate is higher than it should be, even given the movement of people in and out of the labor force.

Take a look at the following chart. On the right hand axis (black) I plot the unemployment rate. On the left hand axis (blue) I plot the 4-week average monthly number of first time applicants for unemployment as a share of the labor force. Very crudely, this is the percent of workers losing their jobs. (In normal times, the number of applicants might be 300,000-350,000; I normalize this to the labor force because it is growing over time, and its important to note that 350,000 is not as problematic as it was 30 years ago).

Note how closely these two series have moved together over time. As new jobless claims as a share of the labor force drops, so too does the unemployment rate, albeit with some lag. However, look at the past 12 months or so (the rightmost data). Here we see a much larger gap between the rate and the jobless claims. Is it possible that this gap is “too big” to be supported in the long run? And if so, can we expect a faster decline in the unemployment rate than we might normally expect, with the unemployment rate catching up to the jobless claim numbers? Still working through this idea, but it will be interesting to watch what happens over the next 8 weeks.Image

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