FOMC policy makers have emphatically stated that they will maintain an accommodative monetary policy until the unemployment rate reaches 6.5%. However, in recent speeches and testimony, Chairman Bernanke has also stated that the 6.5% number is only a guidepost and conditions in the labor market more broadly will ultimately determine if and when the Committee will begin to change its policy. This raises the obvious question, what are those conditions, and what will the Committee be looking at beyond just the 6.5% rate, which the BLS calls the U-3 unemployment rate? Perhaps the most clear and detailed description of what those factors might be was presented by Governor Janet Yellen in her address before the National Association of Business Economics, March 4, 2013.
In that talk Governor Yellen noted that while labor-market conditions were improving and the unemployment rate had declined, they were far from healed. As evidence, she cited several key concerns including that fact that there were some 800,000 workers who were classified as “discouraged” and had given up even looking for a job. In addition, she noted that another 8 million workers were employed part-time but would rather have full-time jobs.
BLS provides several different data series on unemployment that it calls the U-3, U-4, U5, and U-6. The differences between these series are as follows:
U-3 unemployment rate is the rate most widely cited as the official unemployment rate (and it is the one the FOMC used when it set a trigger of 6.5%).
U-4 unemployment rate includes U-3 but then adds in the so-called “discouraged workers” – those who have stopped looking for work because of current economic conditions.
U-5 unemployment rate adds to the U-4 workers who are regarded as marginally attached to the work force and those who would like to have a job but have stopped looking recently.
U-6 unemployment rate adds to the U-5 workers who are working part-time but can’t find full-time work because of current economic conditions.
For convenience, we have posted on the Cumberland website a chart that show these four series and how they move together (u3 through u6). This and the following chart help to pinpoint exactly where the current problems are and who have been and are currently being impacted by the recession (sources of difference). The charts clearly show that in addition to the 7.7% currently unemployed, another 0.6% would be classified as “discouraged workers,” 0.9% would be called “marginally attached” to the work force and have stopped looking for a job recently, and a whopping 5.1% are working part-time but would prefer having a full-time job. As the second chart demonstrates dramatically, it is this last category that was most impacted by the downturn. Between Jan 2000 and Dec 2007, the percentages for the three categories averaged 0.2%, 0.7%, and 2.8% respectively. The biggest impacts have been on the people who are reflected best in the U-6 unemployment rate, which presently stands are 14.3%. Other available data show that these workers are primarily the young, minorities, and those lacking a high school diploma. The bottom line from these charts is that it is likely that the FOMC will not view labor-market conditions as being sufficiently repaired, despite improvements in the overall unemployment rate ( U-3), until the gap for part-time workers has been returned to somewhere near its historic norm and there is measured improvement in the job situation for minorities and the young.
But there is more to the story when it comes to assessing labor-market conditions. While the financial press and policy makers focus on the weekly new claims for unemployment insurance and the monthly job-creation numbers, what gets lost is the fact that, in terms of economic significance, 357,000 new claims today are not the same as 357,000 new claims were in 2000. And the same is true for the new job-creation numbers. This is because the labor market is constantly changing in size, and normally is expected to grow at slightly less than 1% per year. Put another way, 357,000 new claims today are less significant and suggest a much better labor market than they would have in 2000 because the labor force today is larger than it was then by some 5 million workers. Similarly, while the recent job-creation numbers in the range of 200-236,000 suggest a rebound in job creation, the picture is not a bright as trumpeted because of the larger labor force.
Our final chart provides some context for this observation. It shows the monthly ratio of new claims for unemployment insurance as a percentage of the labor force and the monthly ratio of new jobs created relative to the size of the labor force (monthly jobs created). Two facts are abundantly clear from this chart. First, the new claims data are much less volatile than the new jobs numbers, which suggests that one needs to observe more months of continued job growth to be able to identify a trend. Second, the current job-creation numbers are substantially below what one might expect during a time of stable economic growth. For example, given the current labor force (and this does not consider the fact that the labor force has contracted by some 6 million workers from its peak of about 134 million in 2009), the economy would have to create an average of about 273,000 jobs per month for the ratio of job creation to labor force size to equal what it has averaged historically during periods of prolonged expansion and labor-market stability. That number would be 284,000 if the labor force were the same size today as in 2009.
So, what does all this tell us about the kinds of evidence the FOMC is likely to be weighing as the standard measure of unemployment approaches its guidepost of 6.5%? We think it suggests that, for the FOMC to act, it will have to see marked improvement in conditions for part-time workers and evidence that they are moving from part-time to full-time employment. There will have to be substantial gains in youth and minority employment, and job-creation numbers stronger than the 200,000 per month we have observed recently, before the FOMC could justify a move from accommodation. Two caveats to this general conclusion are warranted, however. The first is that it is assumed that inflation remains relatively benign and in the 2.0-2.5% range and inflation expectations are well-anchored. The second is that it is possible that the FOMC may cease reinvesting maturing assets, as it has so indicated, several months before making changes in the federal funds rate. We don’t expect these moves to take place until, at the earliest, near the end of 2014 or well into 2015.
Source: Cumberland Advisors Commentary