The labor force, which forms the denominator of the standard
unemployment rate (also known as U-3), consists of all persons who are working
or have actively looked for work in the preceding month. People who want a job,
but have stopped working, are omitted from both the numerator and denominator.
In a typical month, there are millions of such labor force dropouts, even
though they are not reflected in the standard statistics.
In an effort to take at least some of those labor-force
drop-outs into account, the BLS publishes a supplementary index known as U-5,
which includes discouraged and marginally attached workers in both its
numerator and denominator. These groups include all those who want a job and
have looked for one within the past year, but not within the past month.
Discouraged workers cite their belief that there are no jobs to be found as their
reason for not looking for work. Marginally attached workers give other
reasons, such as family responsibilities. People who say they want a job but
have gone longer than a year without looking for one are not counted in either
U-3 or U-5.
Researchers at the Richmond Fed maintain that U-5 represents
only a crude improvement over U-3. The problem, they say, is that neither of
the official indexes takes into account the fact that different groups of
workers have different rates of transition to employment from month to month.
For example, about 28 percent of the short-term unemployed (those out of work
for 26 or fewer weeks) find a job each month. At the other end of the spectrum,
the transition rate for people who report that they are retired and do not want
a job is just 1.4 percent.
Interestingly, transition rates do not differ much for other
groups of workers. Among people who want a job but do not have one, transition
rates run between 12 and 15 percent. The long-term unemployed (out of work more
than 26 weeks but continually looking), discouraged and marginally attached
workers, and people who are not looking at all but still say they want a job
all fall in that range of transition rates.
According to research
first published by Richmond Fed economist Andreas Hornstein, San Francisco
Fed economist Marianna Kudlyak, and McGill University economist Fabian Lange, transition
rates are the key to constructing a more accurate labor market index. Rather
than arbitrarily including or excluding certain groups, as the BLS does, they
construct an index that includes everyone, but weights their importance
according to each group’s transition rate. In the resulting non-employment
index, for example, each short-term unemployed person (transition rate of 28
percent) gets twice the weight of someone who is not looking for work at all
but claims to want a job (transition rate of 14 percent).
The following chart shows the three indexes, the standard U-3, the
supplementary U-5, and the non-employment index, side by side. U-3 and U-5 vary
much more than the NEI over the course of a business cycle, because they
exaggerate the effect of movements from, say, long-term unemployment to discouraged
worker status, or from marginally-attached to out of the labor force. The NEI
more accurately accounts for importance that workers outside the standard
measure play as a reserve of available labor.
Note that all three indexes have now returned to their
pre-recession lows. The implication is that there is little merit in the
contention that official unemployment measures overstate the recovery of the
labor market. The Fed should not worry about that issue. There is no more
hidden slack in the labor market now than there was before the Great Recession
began.
Reposted with permission from TalkMarkets
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