Will the Real Unemployment Rate Please Stand Up?

January 11th, 2014 at 10:29 pm

Obviously, the main problem with high unemployment right now is the joblessness for those looking for work and those who’ve given up for lack of opportunity, along with the absence of wage pressures for the millions of active workers who depend on tight labor market for the bargaining power they otherwise lack.

But there’s another big problem, one that’s more technical in nature: what is the unemployment rate?

If your answer is 6.7% as per the Bureau of Labor Statistics, you’re low-balling it.  Because of the sharp decline in the labor force in recent years, that number provides a downwardly biased take on labor market slack.  Estimating the magnitude of that bias happens to very important, because the tautness of the labor market as measured by the unemployment rate is a key policy input both at the Federal Reserve and Congress.

For example, the Fed has signaled that they view 6.5% as the jobless rate at which they’ll start thinking about raising the federal funds rate (the key interest rate they set to raise or lower the cost of borrowing; it’s been near zero for years).  Well, if you believe the BLS number, they’re almost there.  But if you think the official rate is biased down, the Fed is still some ways away from that target.  (To be clear, none of this a criticism of the BLS, one of my personal favorite agencies.)

It’s as if your speedometer is off kilter such that when you’re driving 40 mph it says 60 mph.  Under those conditions, you’d be likely to put on the brakes to slow down before you really wanted to.

A tiny bit of arithmetic will help here.  Typically, the unemployment gap is thought off as u – u*, where u is the actual rate (6.7% right now) and u* is the lowest unemployment rate the economy can handle without triggering spiraling price growth, or the NAIRU (non-accelerating inflationary rate of unemployment).  If you believe the CBO’s NAIRU of 5.5%, that gap is a not-all-that-big 1.2 percentage points (ppts) right now: 6.7-5.5=1.2

But something’s missing: a term to reflect the gap in labor force participation.  That is, there’s considerably more slack in the job market than u – u* reveals, because a bunch of potential workers have given up looking for work and are thus not counted in ‘u.’  Another way of saying this is that u is biased downward.  If that bias amounts to, e.g., 2% of the labor force, then u – u* should really be 8.7-5.5, or 3.2 ppts.

In other words, these days the proper slack equation is u + lfg – u* where lfg is the labor force gap (or, using the 2 ppts I just mentioned, 6.7+2-5.5).

Now, there’s a cottage industry among economists trying to guesstimate lfg so as to adjust that equation and get a more accurate bead on labor market slack.  The labor force participation rate, as I noted after last jobs report, is down about three-and-a-half ppts off of its pre-recession peak, but demography is at work here, as opposed to weak demand, as aging boomers leave the labor force for retirement.  So there’s lots of argumentation as to how much of the decline to assign to cyclical slack and how much would have happened anyway.  Or to perhaps put the question more intuitively: how many of those ppts would come back if the job market really strengthened?

I’m not going to spend the time to go through all of the estimates, but I think this is a fair summary: most analysts have assigned most of the drop to the cycle.  A few go the other way, arguing it’s mostly demography, and it’s tricky, because lfg is a moving target (in fact, for most of the data history, the labor force isn’t very cyclical at all).  I thought this paper takes a particularly rigorous look at the question and they argue that the decline is pretty much all cycle, at least through the beginning of last year.  But other careful work disagrees.  (Brad Plumer usefully reviews the issues here.)

So let’s be conservative and say that 2/3 of the decline in the labor force rate is “fixable,” i.e., at full employment it would eventually be reversed.

Then the unemployment gap is: 6.7 + (2/3*3.4) – 5.5 or about 3.5 ppts (that 3.4 is the drop in the labor force rate using quarterly data since its pre-recession peak).  And you will very quickly notice that 3.5>1.2, the latter being the naïve gap as per u – u*.

One last thing.  I wouldn’t be so quick to plug 5.5 into all those equations above.  As Dean and I argue, the NAIRU is probably biased up as well.  If you use, say, 4.5 instead that’s another percentage point of slack.

Fed chair Janet Yellen (still getting used to writing that!) knows this stuff but it’s still worth making a lot of noise about.  It’s certainly not well understood by those members of Congress arguing that the decline in the jobless rate means they don’t need to extend UI.

The real unemployment rate is a good bit higher than 6.7%–forget the speedometer: we’re not going 60…we’re going 40.  So keep that foot off the brake for now.

Update: I just noticed that the great labor economist Heidi Shierholz posted a piece by the same name about the same thing about two years ago.  So, a) sorry to crib your catchy title, Heidi, and b) this problem ain’t new.

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28 comments in reply to "Will the Real Unemployment Rate Please Stand Up?"

  1. TD says:

    The idea that 6.7 is “lowballing it” contributes to the misperception that there is a single “true” rate of unemployment, which is a favorite topic of cranks on both the left and the right. A better way to conceptualize your point might be to say that the fed’s unemployment target reflects a cost/benefit analysis that is understating the costs of the current rate of unemployment because it depends on assumptions about the relationship between this particular measure of unemployment and other measures of human economic misery that do not hold during periods of widespread labor discouragement, etc. But this does NOT mean that 6.7 is no longer a correct measure of unemployment, since unemployment is ultimately an inexact qualitative concept for which we have quantitative proxies that are all correct to the extent that they reflect their narrow empirical definitions.


  2. cfaman says:

    It would appear this extraordinary circumstance will require an extraordinary period of labor tightness to correct. Does anyone else think seat-of-the-pants that we need perhaps ten years or more of a measured 2% unemployment to get back to a more just economy?


    • Kevin Rica says:

      In the late 1960′s there were some parts of the U.S. that had regional unemployment rates as low as 1.5 percent.

      A labor shortage is a good thing.


      • Jared Bernstein says:

        To be clear, you’re not saying that an decline in labor supply generated by weak demand is a labor shortage, even if it shows up as lower measured unemployment. EG, that dynamic does not create any wage pressures to speak of. Under current conditions, the “effective” labor supply curve doesn’t change, though actual labor supply is diminished.


        • Kevin Rica says:

          I’m surprised that you could even think I believed that. If the point needs clarification, let me repost what I said yesterday in a different context, you post on “More on the Jobs Report: Signal-to-Noise Low but Not Zero”.

          Another element of the noise is in the labor force participation rate. Over the long term, there is a lot of noise in that signal because of the long-time trend of women entering the job market, for a variety of reasons.

          A lot of press reporting noted that December’s labor force participation rate was the lowest in 36 years. Except that 36 year’s ago, the women’s movement was hitting full stride. Many more women stayed in the labor force after getting married and even after having children. That was rare previously. Women’s labor force participation didn’t hit 40% until 1965.

          That positive trend covers up a negative trend of men seemingly being forced from the labor market because of lack of opportunities. In May of 1978, the last time the total labor labor force participation rate was so low (62.6), men’s participation was 77.3 (women were 49.4). Total men are down 68.8. Women’s labor force participation is lower than a few years ago, but it’s still up over 7 points compared to May, 1978.

          It’s worse when you look at men of prime working years, 25-54. Back when men were men, their labor force participation rate hit 97.9 in July of 53 when the Korean War Amistice was signed. It’s now 88.0. What are these guys doing? (Serious question!) How are they supporting themselves? Moreover, who are they supporting? If men don’t work, what else are we good for? That 10-point spread conceals a lot of real unemployment.


          • Jared Bernstein says:

            Don’t worry–not accusing you on non-Keynesianism! Just clarifying for all readers.


          • Asdfgh says:

            >>>It’s worse when you look at men of prime working years, 25-54. Back when men were men, their labor force participation rate hit 97.9 in July of 53 when the Korean War Amistice was signed. It’s now 88.0. What are these guys doing? (Serious question!) How are they supporting themselves?<<>>Moreover, who are they supporting? If men don’t work, what else are we good for?<<<

            I, for one, am not supporting anyone, nor do I have any particular interest in doing so (any more than I absolutely have to, for example helping parents with yard work a little sometimes to stay in good relations with them). As for what we men aged 25-54 (I'm 30) who don't work are "good for"… I, for one, have very little idea, and I don't think I care incredibly much either. I don't consider it MY problem (at least until someone manages to make it so, and then only because of that).

            I'm just trying to stay alive and be entertained as best I can, as that's the closest thing to "the meaning of life" that I have been able to come up with. I'm trying to live ascetically and save some cash each month, in case I ever get some other idea.


  3. Larry Signor says:

    The “true” unemployment rate has always been a moving target. During a period of labor slack, increased employment certainly raises the nominal employment rate through motivational channels as more workers are encouraged to re-pursue the search for employment. Increasing the denominator certainly lowers the natural rate of unemployment, or does it? One of those tree falling in the forest things…How do we account for those who have dropped out of the labor force but are now re-entering? There may exist a “true” rate but it is not a fixed nominal percentage of the workforce. It is a lagging indicator which is best understood as a trend, not a definite data point.


  4. Dave says:

    Can I once again express my disgust for the way Obama has handled this? It is as if he doesn’t even recognize the problem. We know this makes him look more in control, more presidential or whatever, but what’s he trying to prove and to whom?

    Just because he doesn’t think congress will do anything tomorrow about this, he pretends the problem doesn’t exist? He should be showing outrage every chance he gets. I know Biden would.

    How many times has he mentioned the damage this is doing to new graduates with huge student loans and no jobs? Why do we have to rely upon Warren to do all the right work?


    • Kevin Rica says:

      The whole group of body snatchers who took over what used to be the Democratic Party thinks that the American economy doesn’t have ENOUGH labor and that is why we need “comprehensive immigration reform” including more legal immigration.


      • Dave says:

        Well, we probably won’t agree on much. I think there’s a misunderstanding here: adding new workers to our economy doesn’t necessarily cause higher unemployment. I’m in favor of more legal immigration. Much more.

        Immigrants are generally very motivated and come here with little to no debt. They help the real economy. But they would help the real economy much more if we had a $15 minimum wage and automatic health care coverage.

        The real problem is foreign labor competition from different economies and different political systems. In the US, we don’t believe in forced labor, 24-7 labor, on-site labor (workers in barracks), etc…


        • Kevin Rica says:

          Dave,

          If you say immigrants are generally, nice, motivated good people; I don’t disagree with you.

          If you say that we have jobs for large numbers of unskilled people, I’d ask you why there are so many unemployed people here now? Do you believe that GW Bush was right when he said that they do “jobs that Americans don’t want?”

          I believe that immigrants are willing to work for “wages that Americans find unacceptable.” We already have enough people to work construction, clean hotel rooms, bus tables, clean urinals, and milk cows. We are only discussing the price. Immigrants are willing to do these jobs cheaper.

          Do you disagree with that?


          • Dave says:

            Yes, I disagree.

            Knowing the economics confirms it.

            We have so many unemployed because of our political system. Unskilled people can become skilled with 1 year on the job.

            Our political system has failed.


      • Larry Signor says:

        The millionaires club is getting too crowded in America (3% of our population), so barriers to entry must be erected. A larger, less utilized labor pool is just such a barrier. Ending UI benefits, cutting SNAP and other basic safety net programs, increased educational costs and opposition to the ACA can all be seen as barriers to entry. Upward mobility has always been an insiders game.


        • Dave says:

          It is a problem of ignorance more any anything.

          The richer the top class becomes, the dumber they become.

          All through history, this repeats. Rich people are dumb. Rich, dumb people cause revolutions because they are so rich and so dumb.

          If we have a system where rich people rule, it will be a failure of epic proportions. No, everyone else is supposed to rule in a democracy.

          Democracy will be restored. Let us hope that rich people eventually acquiesce rather than protest. If they don’t, violence is inevitable.

          Rich people: acquiesce or be doomed.


      • Dave says:

        But don’t get me started on guest workers. The idea that Microsoft and other huge corps can demand guest workers is absolutely outrageous. Shame on Bill Gates and his minions. Shame on anyone that advocates for H1-B workers. People who advocate for these workers are absolutely out of touch with pretty much every social construct we have in the US. They only see money and power.

        Guest worker programs should be outlawed in the constitution.


  5. Noni Mausa says:

    The problem is not unemployment, per se. The problem is that wage employment is the sole legitimate way for a citizen to access the necessities of life. (The other alternatives, neither legitimate by right wing judgment, are charity or crime.)

    In such a system, when employers are the gatekeepers of livelihoods, but choose to open fewer gates than there are willing workers, where does the blame lie? They pick and choose, cut benefits and wages and hours, and dismiss hundreds of workers on a whim. The un-chosen workers are supported grudgingly by tax revenues, or desperately by families and friends, maintaining an idle labour force out of the wages ( second or third hand) of those few working people not chosen by the gatekeepers.

    It is as though people and their government constitute a nonprofit support structure for businesses, rather than businesses being created to benefit Americans.

    Noni


    • urban legend says:

      So all of us who understand need to get off our butts and organize the entire voting population to vote — at which point, when votes trump money at least for Democratic politicians, we will have a chance of getting a government that works for the people. Disillusionment with government — with the Republicans and their backers as the main cheerleaders — is killing our democracy. People who would vote for good things are throwing up their hands and saying, “What’s the use, they’re all alike.” It plays right into the hands of Republicans.


  6. Pinkybum says:

    A good proxy for what for are talking about would be to look at the difference between the U-6 rate and the U-3 at a different time in our history. The closest I can find is January 1994 when U-3 was 6.6 percent and U-6 11.8 percent. The present day U-3 is 6.7 percent and U-6 is 13.1 percent.

    That would suggest that we are off by about 1.3 percent. Of course this doesn’t really take into account participation rate which is the other “X” factor.


  7. Kevin Rica says:

    The fact that NAIRU and estimated potential output tend to adjust adaptively should make us suspicious of their real intellectual value. The conventional wisdom in the economics profession has many views that are really sort of arbitrary and don’t stand much scrutiny. The idea that in the internet age that potential output is constrained by the number of unskilled workers is sort of absurd.

    Measured unemployment is a good index of misery, but it is a useless index of constraints on output.


  8. John Kozy says:

    Ah, Jared. It all a verbal problem that is laughable. Take the students in a school. It’s the student body, isn’t it? Now define student body as comprised of those students who do homework only. You’d laugh as any superintendent who said that. Why don’t we laugh at economists?


  9. Rima Regas says:

    So, we have:
    1. those who were laid off in 08-09 and haven’t found a job.
    2. those who were laid off in 08-09 and have found occasional work, but not a job.
    3. those who were laid off in 08-09 and took low-wage jobs (not in their profession)
    4. those who graduated from college in 08-09 who couldn’t get hired in their profession and took low-wage jobs and still can’t get hired to do what they intended
    5. those who’ve been laid off at their mid-forties to mid-fifties and can’t get hired
    6. those who are graduating from college now and…
    7 teens
    8. who else?

    How can we better paint the employment picture?


  10. wendy beck says:

    I am a lay person, not an economist, and I have a question. What about the increasing numbers who are independent contractors or “consultants”? Are these people counted in the unemployment rate? Many (including myself at times) during hard times get an assignment every few months, some lasting just a day or two. How are these folks counted (or not) in the unemployment rate?

    When I was young, most people (men, mostly) worked for companies. Few, except for shop owners, were independent contractors or consultants. How has the unemployment rate adjusted for this massive change in types of employment?


  11. smith says:

    If other comments are going to address the topic of immigration, then everyone needs to know some more details.
    The proposed new bill (please don’t call it reform) greatly expands employer sponsored workers, both low skill and high skill, temporary and dual track. (dual track means initial temporary workers may apply for permanent status by meeting certain conditions)
    No one admitted under these provisions can start their own business. They must wait until their employer sponsors them for permanent status. The initial temporary term is three years, renewable another three years. So we’re talking 1 to 6 years, and then some. Most new businesses fail, and the success rate of immigrants is not magically better. In negotiating their initial salary, entry into the country is conditional on them accepting an offer. Once here, dismissal for any reason means deportation within three months.
    The numbers we’re talking about are huge, certainly near or more than 10% of new jobs created in a year for both low and high skills.
    The provisions that are supposed to guarantee immigrants are only offered jobs that could not be filled by non-immigrants are provably phoney, always have been and always will.
    The only common sense approach is to eliminate employer sponsored immigration (corporate welfare) altogether and allow however many high and low skilled workers you want to immigrate, free to negotiate their salary, free of the threat of deportation, free to strike, free to quit, free to start their own businesses. If you have trouble picking a number, just use last year’s.
    Scrapping the current proposal for a free labor bill would cause Republican rejection and set up an election the Democrats could win. Passing the current proposal takes Republicans off the hook and the Democrats lose, labor loses, even immigrants lose, and inequality grows.
    It’s a shame no economist, no liberal economist, no liberal labor economist, has taken this position. No tightness in the labor market will ever counter 10% of the workforce working harder for lower wages to avoid deportation (and that’s especially true if the new bill passes!).


    • Kevin Rica says:

      “The only common sense approach is to eliminate employer sponsored immigration (corporate welfare) altogether and allow however many high and low skilled workers you want to immigrate, free to negotiate their salary, free of the threat of deportation, free to strike, free to quit, free to start their own businesses.”

      And free to offer to take anyone else’s job at 10% less until the U.S. and Mexican labor markets and wages merge into one. (Until the Haitians come and drive wages even lower).


  12. urban legend says:

    It’s just so hard to take the concept of the NAIRU seriously in a time like this. The concept seems to be entirely about wages, and is based on a prediction that at a certain point worker demand for higher wages will accelerate — i.e., go into an out-of-control spiral. That happened in the 1970s and never has again. I’m not sure it ever did before that, either. (If so, when?) Surely not before the Wagner Act. With unions as weak as they are today, the idea that this will happen when we hit an unemployment rate of X seems ludicrous — especially so when the employment-to-population ratio is as utterly dismal as it is. It will take a long, long time before demands for wages get a life of their own that outpaces ordinary inflation or represents any more than a necessary recovery in wage levels.

    I frankly find it disturbing that the Fed seems to take the NAIRU seriously at this time. It seems like a case where the models being used depend on it, and therefore it must exist.


    • smith says:

      NAIRU is real, and comes into play even above 5.5% official unemployment, if businesses are monopolistic, or made of oligopolies (just a few dominant firms) and unwilling to give up any profits to wage increases. Instead of labor gaining a slightly larger share of the pie, businesses counter any increase in wages with price increases. That is what happened in the 70s until the double dip recession of Reagan broke labor in the 80s. Downsizing, and physical migration of businesses to the South and overseas added to labor woes in the 1990s.
      Tightening the labor market and strengthening labor power will not work unless this issue is addressed.
      The phenomena was well documented in this 1973 book:
      http://en.wikipedia.org/wiki/Economics_and_the_Public_Purpose
      I disagree with the socialist solution of nationalization, but not addressing the problem is a recipe for disaster. Labor will be blamed for inflation, stagflation, and suffer the consequences again. Businesses, corporations, and rich people will not give money to labor, and if forced to by slightly tighter labor market, they will just raise prices. They did this in the auto industry even when it hurt sales.


  13. Justin says:

    Mr. Berstein and Other Economists:

    I am not an economist either. I do not understand why there is not just ONE unemployment figure. Seems simple to me. There is a population of people called the workforce. A certain percentage of the workforce do not have jobs for a variety of reasons – they can’t work, do not want to work, have a disability, cannot find work, are on welfare, live in their parent’s basement (nice Warcraft reference by the way….)

    All of those people add up to a percentage of the work force that is not working, hence the unemployment percentage.

    Is it close to 7%, 14%, 20%? What is the actual number? Or, if in your view my take is an oversimplification, which it very well could be, what is the closest estimate to a percentage figure you can make?

    Thank you.

    Justin


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