Should President Obama Cheer the Decline in the Unemployment Rate?

While the latest March Jobs Report signaled that the nation’s unemployment rate is on the decline, that number still far exceeds the Obama administration’s projected rates as a result of the American Recovery and Reinvestment Act passed in February 2009, a reality that is quite disheartening.

The official number by the Bureau of Labor Statistics (BLS) of non-farm payroll jobs created in February was 216,000. This appears to be a positive sign for the labor market and the future of our economic expansion. In addition, the unemployment rate continued to decline, as explained in a Wall Street Journal article: "The unemployment rate, which is obtained from a separate household survey (compared to the establishment survey for the number of jobs created), edged down to 8.8% last month, the lowest level since March 2009. Since November 2010, the jobless rate has declined by a full percentage point. Still, there are about 13.5 million people who would like to work but can't get a job."

The Obama administration had projected that the unemployment rate would not rise above 8% with the recovery act in place, and without it, the rate would not rise above 9%, figures which are shown in a graph by James Pethokoukis (who is a Money and Politics columnist for Reuters Breakingviews). It is apparent that the unemployment rate has risen faster and remained above these projections. 

Explanations for why their projections were so far off could be based on whether their estimates were above or below the actual unemployment rate. If you assume that the stimulus package was effective in stimulating job creation, then their projected unemployment rates should have been much higher to begin with and the decline in economic growth was worse than they assumed in their model. On the other hand, if your prior is that the projections made before the recovery act were fair and the recovery act was just not effective in creating jobs, then it may be that the stimulus funds were not spent as quickly as expected and higher budget deficits from the increase in government spending slowed job creation by firms expecting higher taxes or lower government spending in the future to pay for those deficits. 

In my humble opinion, the high unemployment rate is the result of a combination of the above explanations. In particular, I believe that in a dynamic economy, it is difficult to accurately predict what will happen in the future, but government stimulus cannot direct individuals and firms to act in a specific way; therefore, it is further evidence that fiscal policy is not effective in stimulating the economy unless you reduce the choices made by economic agents. The latter of which is not an optimal scenario in a free society.      

Although these are issues that should be analyzed further to determine what to do or not to do in future economic contractions, does the recent drop in the unemployment rate necessarily mean that everything is peachy in the labor market?

Princeton Economist Alan Krueger does not seem to think that everything is looking up. He expects a further decline in the unemployment rate from expiring unemployment benefits, a shift of those unemployed to expand their education or training, and those that will continue to drop out of the labor force after giving up the search for a job. Therefore, the unemployment rate may continue to decline, but the signal about the labor market from this measure is unclear. 

Why might the unemployment rate not be the best measure to use for analyzing the labor market? Simple. It is the way that the unemployment rate is calculated, where the calculation is the number of unemployed that are still searching for a job within the past four weeks divided by the labor force. Considering the fact that many unemployed workers have decided to drop out of the labor force, there is downward pressure on the unemployment rate as the numerator and denominator fall. For example, three-fourths is greater than two-thirds. Therefore, the unemployment rate has a volatile component for a numerator and a volatile component in the denominator, making this measure very volatile during business cycles and less important in telling us much about the labor market.

Conversely, a more reliable indicator of the labor market is the employment-to-population (E-to-P) ratio. This ratio is calculated by taking the number of employed workers divided by the working age population, which are those that are sixteen and older. While the numerator is volatile, the denominator is relatively stable over time; therefore, this ratio gives a much clearer picture of the labor market. From the BLS report above, the E-to-P ratio increased by .1% to 58.5%, where an increase is a positive signal, but this percentage was close to 63% when the recession begin and has not been this low since 1983!  

What does all of this mean for the future of the labor market? There is still much further to go before we have a strong labor market. The optimist in me wants to feel better when the unemployment rate falls, but I keep in mind that the E-to-P ratio has been moving sideways when trying to evaluate the labor market. Therefore, the actions taken by the Obama administration may have had the best intentions in mind when formulating their plan, but government meddling in the economy typically pushes off the corrections in the market that are necessary for economic prosperity to thrive. Will we learn what to do differently in the future? Time will tell…

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