SF Fed: The Labor Market Is Stronger Than You Think

Photograph by Robert Daly

The unemployment rate has fallen two full percentage points in the past three years, from 9.5 percent in August 2010 to the current rate of 7.3 percent. As good as that looks on paper, buckets of cold water have been thrown at it since much of the decline is the result of people dropping out of the workforce, pushing the participation rate to its lowest level since 1978. Total buzzkill.

A new paper from the Federal Reserve Bank of San Francisco offers some fresh hope that the labor market is actually doing quite well, that the lower unemployment rate isn’t just a function of people giving up, and that the rate of job creation is gaining momentum.

Economists at the SF Fed tease out six indicators that serve as “excellent predictors” of future improvements in the unemployment rate, and they are even better forecasters than recent changes in the unemployment rate, which is itself a lagging measure. The six measures are listed in the table below, ranked from top to bottom according to their predictive power. The unemployment rate is up top for the sake of comparison.

The greener, the better
Federal Reserve Bank of San Francisco

First, look at the numbers in bold, which measure the correlation between the indicators’ momentum and changes in the unemployment rate—i.e. how predictive they are. In the authors’ own words, “Our main interest is identifying those indicators whose movements over the past six months are most highly correlated with changes in the unemployment rate in the next six months.”

So the strongest predictor is the insured unemployment rate, with a correlation of 0.44.

Now look at the far right column. The more negative the number, the faster the decline in the unemployment rate is expected to be over the next six months. The darker shades of green indicate the strongest signals for the pace of the recovery. So the indicators that matter most are improving the fastest. The paper’s authors take this as “evidence that the recovery in the labor market is robust, broad-based, and likely to continue, if not accelerate, over the coming months.”

One more chart:

Getting closer to historic averages
Federal Reserve Bank of San Francisco

This shows that a broad swath of labor market indicators are returning to their historic averages, which is deliniated by the horizontal line at 0. Some (initial jobless claims, unemployment insurance rates) are well below that average.

One more thought about the San Francisco Fed: This is the bank where Janet Yellen spent several years as president in the mid-2000s. While she inherited a sleepy outpost when she got there in 2004, by the time she left, the SF Fed had become a robust center of substantive and (more importantly) accurate macroeconomic research. No reason to think they’re not onto something here.

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