Evan Soltas
May 10, 2012

For Better and Worse

Here's something I don't understand: the idea that the fall in the unemployment rate since 2009 represents "progress."

Everyone agrees that falling labor force participation is bad, and everyone knows that the employment-population ratio hasn't budged for two years now. So how does the fall in the unemployment rate represent anything else than a bad thing? All it means is that the workers who need to find jobs are one further step away.

In fact, if you were to hold the labor force participation rate constant from December 2007 -- the start of the recession, as judged by the NBER -- and add in a demographic adjustment for the aging of the population (that has an effect on trend labor force population), you'd find that we haven't made any true progress on unemployment since the end of recession (June 2009).

The "labor force adjusted" unemployment rate is 10.0 percent as of April 2012. It makes you wonder: how different would policy be right now if we pretended the unemployment rate was 10.0, and not 8.1, percent. Very different, I imagine. That's the policy we should have.As the official unemployment rate falls, monetary policy is falling prey to the McNamara fallacy -- the mental trap of making decisions based on easy or common metrics which do not reflect reality. The concept comes from Secretary of Defense Robert McNamara, who thought he could monitor the course of the Vietnam War based on the enemy body count. In our case, assuming that a falling unemployment rate means improvements in economic conditions and in labor markets is an incorrect conclusion. Its decline, rather, represents worsening perception of employment opportunities, and more broadly, of economic conditions.

Although unemployment is significantly worse than the headline numbers and policy consensus reflects, there is cause for optimism, as seen by some under-the-radar improvement in private job openings, which spiked upwards in the JOLT (Job Openings and Labor Turnover) survey -- see here. Quits, which reflect employee confidence in their ability to find another job, have also broken out of their slow-but-steady increasing trend.

The progress, in particular, seems to be coming from major gains in the manufacturing sector. I posted this graph on Twitter this morning in anticipation of this post.Job openings have increased by roughly 80,000 a month, from 261,000 to 326,000, since the start of the year. That's the underlying force pushing up the broader measure of private job openings. This is probably a reflection of understaffing in manufacturing firms, which are increasing average hours to their highest in over a decade while they seek new hires.