The Demise of the Unemployment Rate as a Measure of Economic Health

The Demise of the Unemployment Rate as a Measure of Economic Health

For those who follow the unemployment rate as a gauge of economic health, the verdict is in: the unemployment rate is unreliable and not a good measure of the strength/weakness of the labor market.

Since the recovery began, there has been a lot of discussion and debate over the rapid decline in the unemployment rate. The problem that has been identified is that demographics are having an impact on the unemployment rate. As the baby boomers retire the normal pattern is that they leave the work force because they are no longer working. Given the way that the unemployment rate is calculated, all else being equal, a decline in the labor force results in a decline in the unemployment rate. So, the retirement trend for the baby boomers distorts the strength of improvement in the unemployment rate that has occurred since the recovery began.

The problem is that the dynamics of the labor market are changing faster than the government’s models can handle. I participated in a symposium yesterday that included a labor economist from the state of Idaho. If there was any doubt about the problems with using the unemployment rate as a barometer of economic health, he did his best to remove that doubt. His point was that the unemployment rate is a rate that is seasonally adjusted to remove month to month distortions. The problem is, the government models that are used to calculate these seasonal adjustments cannot effectively handle the demographic influence that is occurring.

That is the reason why economists, financial markets and the media have shifted their focus to the amount of jobs being added each month. You have probably noticed that the media no longer leads with the story on the nation’s unemployment rate. The “breaking news” is now all about how many jobs were created. This was illustrated today when the Bureau of Labor Statistics (BLS) released their data on the nation’s employment situation for October. There was little focus on the fact that the unemployment rate fell from 5.1% to 5.0%. Instead, the big news was the fact that the number of jobs created in October far exceeded what had been forecast. The nation added 271,000 jobs compared to the consensus forecast of 187,000.

This news caused bond yields to move higher as the bond market appears to have decided that the Federal Reserve (Fed) will now begin the process to normalize interest rates (i.e. raise rates) in December. After the disappointing results in September, when the number of jobs was below the consensus forecast, bond yields dropped and the markets (as measured by the futures market) assigned a probability of less than 20% that the Fed would raise rates in December. The probability forecast gradually rose because of speeches by Fed officials to the point where the probability stood at 56% before today’s report. As the probability forecast rose, yields also rose. After today’s jobs report, the odds surged to 70% and interest rates spiked higher. This was all focused on the fact that number of jobs being created was far more than forecast, not the drop in the unemployment rate.

Going forward, if you feel the urge to follow economic data related to employment, focus on jobs creation rather than the unemployment rate.

If you would like more detailed analysis of economic reports released each month, sign up for my Economic Update newsletter. Use the “sign up” feature that is in the lower right corner of this blog.

About The Author

Steve Scranton is the Chief Investment Officer and Economist for Washington Trust Bank and is a CFA charter holder with over 30 years of investment experience with equities, tax-exempt and taxable fixed income securities. Steve actively participates on committees within the bank to help design strategies and policies related to client and bank owned investments. Steve also serves as the economist for the Bank and has been a featured speaker for both client and professional organization events throughout the Northwest.