For some time, the monthly release of the US unemployment rate has been seen as much more than a snapshot of conditions in the real economy. It has also provided important insights on the likely actions of the Federal Reserve, America’s most important economic policymaker and the world’s most powerful central bank.
This situation is evolving on both fronts, and the implications are widespread.
Many more people now recognise that the unemployment rate is only a partial and imperfect measure of the health of the labour market. Specifically, the information content of U3 — which measures the number of unemployed people as a percentage of the civilian labour force, and has fallen steadily from a high of 10 per cent in October 2009 to 6.7 per cent today — is undermined by significant changes in the labour participation rate and the stubborn persistence of long-term joblessness. No wonder the Federal Open Market Committee observed in the minutes published on January 8 that, notwithstanding the decline in the unemployment rate: “A range of other indicators had shown less progress towards levels consistent with a full recovery in the labor market.”
These limitations do more than reduce the value of the unemployment rate as a widely followed lagging indicator. They also undermine its effectiveness as a leading indicator of macroeconomic policy changes.
You can already see this in the extent to which the Fed is trying to wean markets away from focusing excessively on the unemployment “threshold” that the institution itself put out there as influential in determining changes its policy stance. Instead, the Fed is slowly extending the concept of thresholds to a wider array of variables, including more holistic measures of the labour market and, more importantly, inflation targets that are in excess of the current (and projected) rate.
There are two other reasons why the unemployment rate is now a less effective predictor of policy changes.
First, Fed policy has been placed largely on autopilot. Consistent with Fed signals, we should expect a regular “measured reduction” in asset purchases at forthcoming policy meetings so that the institution is out of the quantitative easing business by the end of the year. Indeed, only major turbulence at home would prompt the Fed to override this autopilot course.
Second, and now that the economic recovery appears better entrenched, officials have greater flexibility to consider the potential negative consequences of prolonged reliance on experimental policies, including the impact on asset prices, the functioning of markets and asset allocations.
All this suggests that, in deciding how to react to new economic data, Fed policy will place less emphasis on the unemployment threshold as such and more on inflation and other real economy indicators. So what does this mean for the usual rituals – and great anticipation – associated with the monthly release of the US employment report?
Certainly, the fanfare around this data release will not end. “Employment Friday” will remain – at least for a while – one of the most widely followed data releases, not only nationally but also internationally. Yet, unless analysts get their forecasts really wrong, we should expect the report as a standalone to have a diminishing role as a notable mover of asset prices and policies.
Mohamed El - Erian
FT
