The Unemployment Rate Isn’t Used to Keep Unemployment Low (with Graph)

Years ago, I complained to my friend Stirling Newberry that the unemployment rate didn’t seem to track how good the economy felt, or how many people were in desperate need of employment.

The unemployment rate was, then, and is now, taken as a proxy for the health of the economy for ordinary people. However, I could see and feel that the economy was getting worse for ordinary people, and that fact was showing up in other statistics. Plus, unemployment rates that were considered a crisis when I was young in the 70s, were now considered acceptable.

(See: The Economy Has Not Recovered, With Graphs)

Stirling said, “You need to know who an economic statistic is designed for, and what they use it for.”

A little history is necessary here, about inflation. In the 70s, due to the oil crisis and other mishandled economic problems, inflation got out of control in the West. Very high interest rates were used to bring it down, by Chairman Volcker at the Fed. Western policy makers became obsessed with inflation. It was considered Enemy Number One. They decided that the worst cause of inflation was wage increases and called this “wage push inflation.”

To track this, they turned to a statistic called the non-accelerating inflation rate of unemployment (NAIRU). NAIRU was the rate below which the unemployment rate was assumed to cause inflation.

The unemployment figure measures the number of people actively looking for jobs, compared to those who have jobs, remember. Thus it measures the active demand, in the market, for a job. Therefore, theoretically, if there are too few people looking for jobs, employers are expected to have to raise wages to attract workers.

(This is, to be clear, when wages rise the most, which is something non-economists and non-oligarchs want to happen.)

If you are old enough, you will remember that during the 80s and 90s, and even into the 00s, when the unemployment rate would drop, the stock market would take losses. This is because stock investors expected the Federal Reserve to raise interest rates, which is bad for the economy and bad for stocks.

So, the unemployment rate from late 70s and on, has been used to determine if wages should cause inflation, and to then raise interest rates to make sure they don’t.

Not incidentally, the result is also to crush wages, because, essentially, wages that improve are nothing more than wages that increase faster than non-wage inflation.

The unemployment rate not only doesn’t measure how good the economy feels for ordinary people, it was actually used, with purposeful action, to crush wages.

You’ve all been waiting patiently for your pretty graph, so here it is.

You’ll notice that while effective federal funds rates (the green line) increase during low unemployment periods (the red line) before Volcker, it is after Volcker that they correlate strongly to whether the unemployment rate is approaching or below NAIRU. Before Volcker, the unemployment rate is often below NAIRU and people get a lot of raises.

Note, in particular, and with amusement, that the flat, blue line rate (the natural rate of unemployment) in recent years shows a period where unemployment has stayed above NAIRU. Note that Yellen started talking about increasing rates as the unemployment rate came closer to NAIRU.

Your wages were crushed, deliberately, supposedly to crush wage inflation.

And this is why unemployment doesn’t have very much to do with how the economy feels for ordinary people, especially not now (it effects how the economy feels some, but not much). Unemployment has to get below NAIRU and stay there for you to get real wages.

I will point out, for completeness, that the idea that wages are the most important source of inflation is questionable, but I’ll deal with that at a later date.

(Read: A More Detailed Look at the End of the Post-war Liberal Era)

Originally published Feb 17, 2006. Back to the top because it is an actually important post. We just recently had another case of the stock market declining due to low unemployment rate figures. This is why.

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