07 February 2014

Unemployment Rate as Leading Indicator for Total Employment?

The unemployment rate is down 1.3 percentage points in the last 12 months, its biggest improvement in this century. It is particularly impressive that its made this gain after 46 straight months of job creation. This recovery is not exactly fresh.

The negative explanation is that the unemployment rate is dropping because people are dropping out of the labor market. The positive explanation is that its dropping because people are finding jobs.

Here is a graph to trace the change in total employment (the blue bars) against the change in unemployment rate (the orange line). Unsurprisingly, these two move together well; more jobs mean a lower unemployment rate.

Recently, the unemployment rate has dropped sharply even as job growth has faltered. (Look at the sharp upturn in the orange line in the just the last few months.) The simplest explanation is that people are leaving the work force, bringing down the unemployment rate not because of an increase in the number of people with jobs but because of a drop in the number of people still looking for work. That could be the biggest explanation of what is now happening, but I think the odds are better that this is actually an indicator of what's to come.

Because it is curious to see that - for whatever reason - the unemployment rate seems to move ahead of changes in total employment. Note that the unemployment rate worsened ahead of a drop in job creation in 2001 and 2006 and then improved ahead of job creation in 2002, 2004, 2008 and 2011. More often than not, unemployment rate changes have been a leading indicator of job creation during this century, changing direction more quickly than the net change in jobs.

Given household debt is down and the deficit is one third what it was at the height of the recession, consumption and government spending are more likely to expand than contract this year. Confidence is up. Household wealth is up. All indications are that domestic and international drags on economic expansion are behind us for now. There are good reasons to believe that this sharp improvement in the unemployment rate is indeed a leading indicator of good things to come.

And if it is, 2015 could be the first year since the 1990s to feel like an economy firing on all pistons.

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