The unemployment currently sits at 7.6%. If America adds jobs, then that rate goes down.
But that’s not the only thing that’ll make it fall.
If American’s drop out of the labour force, then they can’t complain about not having a job. So they aren’t factored into the unemployment rate equation.
In other words, if the labour force participation rate (LFPR) falls, then all things being equal, the unemployment rate will fall as well.
Now, the Federal Reserve had said that a 6.5% unemployment rate target would be one of the two measures it would use in guiding decisions about monetary policy.
However, Fed Chairman Ben Bernanke has also said that the current unemployment rate may be misrepresenting the health of the job market.
“If a substantial part of the reductions in measured unemployment were judged to reflect cyclical declines in labour force participation rather than gains in employment, the Committee would be unlikely to view a decline in unemployment to 6-1/2 per cent as a sufficient reason to raise its target for the federal funds rate,” said Bernanke in a recent testimony.
For economist trying to forecast when the Fed will taper its quantitative easing program and tighten monetary policy, these comments complicate things a bit.
So the fine folks over at Barclays took it upon themselves to look at any recent comments that members of the Fed have said regarding the labour force participation rate.
Some commentary from Barclays’ US Rates Strategy team led by Rajiv Setia:
A continued fall in LFPR poses a risk to rates
Given the Fed’s increased emphasis on the unemployment rate that we have documented for the past few weeks, a continued fall in the LFPR poses a risk for rates; by our estimates, consensus expectations for unemployment assume flat LFPR. A decline in participation would cause the unemployment rate to fall at a faster pace than the Fed and consensus are presuming.
…the LFPR has dropped nearly 2% since the end of the recession, accounting for a significant part of the decline in the unemployment rate (the employment- population ratio has improved very little since the recession ended). But the implications for monetary policy, and hence the future path of rates, are very different depending on the reason behind the decline in LFPR. A view that the current low level of the LFPR is cyclical argues for a more dovish policy, while a view that it is mostly demographic argues for a more hawkish policy. Clearly, how the LFPR evolves over the next year will be critical to the rates market.
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