Monday, January 11, 2010

Adjusted Unemployment Rate Analysis

As reported last Friday, the nation’s unemployment rate remained constant at 10% in December despite an additional 85,000 reduction in non-farm payrolls.

While declines in the nonfarm payroll number are likely to have ended last month, simple math suggests that the unemployment rate should continue to increase as the economy improves.

As noted in the analysis below, the Bureau of Labor Statistics reports that approximately 1.9 million Americans have left the labor force since May 2009 (when the work force peaked at 155 million people). Since these people are assumed to have left the available labor pool, they are not included in the calculation of the nation’s unemployment rate. In my back of the envelope analysis, I calculate that December’s unemployment rate would have been closer to 11.1% had the government not assumed that nearly 2 million people left the labor force.



As the economy improves (hopefully!), many of these uncounted civilians will reenter the labor pool, placing pressure on the denominator of the unemployment rate calculation. Further, natural population growth in the United States suggests that the economy must create between 125,000 and 150,000 jobs per month to absorb those incremental Americans looking for work. As such, even if nonfarm payrolls turn positive, the employment rate will trend up unless we get a fairly pronounced recovery.

As noted in the chart below, it wasn’t until early 2004 that the economy began comfortably generating in excess of 200K monthly jobs. This was a full two years after the recession officially ended in November 2001. If the trajectory of the current recovery follows that of the last recession, it is highly conceivable that the peak in the unemployment rate may not occur until sometime in 2011. I hesitate to think what the employment rate will grow to if we have a double dip.

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