What Does Unemployment Have to do with the Fed?

The Federal Reserve, unlike other central banks around the world, operates on a dual mandate. Not only is it charged with maintaining a stable price level throughout the nation’s economy, but it is also supposed to play a counter-cyclical role in keeping the level of unemployment stable through the use of strategic monetary policy. For example, if the economy begins to go into a recession and unemployment starts to rise, the Fed will likely respond by engaging in expansionary monetary policy (lowering interest rates and expanding the money supply) in order to stimulate the economy and bring the unemployment rate back down to the natural level.

Where does Unemployment Data Come From?

Unemployment data is not the greatest gauge of economic health, and the official unemployment rate may be deceiving. The Fed uses data which is put together by the Bureau of Labor Statistics (BLS). The BLS doesn’t simply use the number of people collecting unemployment benefits as their unemployment number; that certainly wouldn’t accurately reflect the unemployment level because some people don’t apply for unemployment, while some have their applications delayed, etc. It’s also impossible to count every unemployed person in the entire country, so the BLS conducts the Current Population Survey (CPS) every month. About 2,200 employees at the BLS contact 60,000 households that are carefully selected to, at least in theory, reflect the entire US population. A quarter of the households are rotated out each month too, so it’s not always the same households that are being surveyed.

Individuals are classified as employed when they’re currently working. They’re unemployed if they do not have a job, have actively looked for work in the prior 4 weeks, and are currently available for work. All the employed and unemployed individuals in the country make up what’s called the labor force. However, a large portion of the population isn’t counted in the labor force. Anyone under 16 years old, or not actively looking for work within the last 4 weeks is not counted in the labor force at all. This is where problems with the official unemployment figures start.

To give a bit of history, the CPS has been conducted every month since 1940, but it has undergone many changes since then. A major overhaul took place in 1994, prior to which the survey was conducted by mail. The changes in 1994 were aimed to computerize the process in order to more precisely measure unemployment and expand the amount of data available, while also changing several definitions to incorporate concepts such as discouraged workers. Several minor changes were also made in 2003, such as adding new race and ethnicity categories.

So, What’s the Problem?

The Fed uses unemployment statistics as part of their calculation when setting monetary policy. If the data isn’t giving a good picture of the state of the economy, then the Fed might end up doing just the opposite of what’s needed, with potentially disastrous consequences.

Additionally, the Fed (and the rest of the the government for that matter) have very strong incentives to maintain the confidence of the general populace. Thus, they have incentives to report low unemployment.

According to the CPS, in February of 2014 the US population over 16 years of age is about 247 million people. Out of these 247 million people who could in theory participate in the labor force, only 156 million people are actually counted in the labor force. So, while February’s unemployment rate was 6.7%, or only 10 million out of the 156 million in the labor force, we’re missing 91 million people who could be working but aren’t counted. How many of these people really don’t want any kind of work?

The BLS has more accurate measures of real unemployment that account for people who are not working for various economic reasons, and who aren’t accounted for in the official unemployment rate. If we take these groups of people into account, the unemployment situation in America begins to look much more dire. Take a look at the following chart:

U4, U5, and U6 account for discouraged workers, marginally attached workers, and workers who are under-employed, or who work part time jobs for economic reasons. Each of these measures are better indicators of the health of the economy, yet U3 is the predominant measure used. It seems possible that those in power would use this measure in their dialogue, because 6.7% unemployment sounds far less intimidating than 13%.

We have not made a strong recovery from the 2008 recession. People are being forced to accept part time jobs, when they are willing and able to work full time, because there is simply not enough work available. Additionally, people have become discouraged from their inability to find work, and have resigned themselves to long-term unemployment (often encouraged by the incentives provided by extensive welfare programs). Yet, according to the U3 measure of unemployment, we are almost back to the natural level of unemployment. Clearly, using U3 to describe the economic health of America is inaccurate, and maybe even deceptive.