Unemployment Numbers Down While Economy Continues to Lag

Something doesn’t quite add up in this year’s economic data, and economists studying it aren’t shy about saying so. The unemployment rate has been falling — meaningfully, by nearly a full percentage point over the past year. Economic growth, by contrast, has stayed sluggish and uneven, nowhere close to the pace textbook models say should be required to drive unemployment down this fast.

A Relationship That’s Supposed to Hold

Economists have long relied on a rule of thumb known as Okun’s Law to describe the relationship between GDP growth and unemployment: roughly speaking, the economy needs to grow meaningfully above its long-run potential rate for the unemployment rate to fall in any sustained way. Growth at or below that potential rate — economists peg the economy’s potential growth rate somewhere around 2 percent to 2.5 percent in the current environment — should, by that logic, leave unemployment roughly flat.

That’s not what’s happened. Real GDP growth limped through much of the past year at rates well below that threshold: just 0.1 percent in the first quarter, 2.5 percent in the second, and 1.3 percent in the third, according to figures cited in a Congressional Research Service analysis of the disconnect. Under those growth numbers, Okun’s Law would predict unemployment holding roughly steady — and for a while, it did, stalling around 9.0 percent through the first three quarters. But growth accelerated to 4.1 percent in the fourth quarter, and unemployment has since fallen by roughly a full percentage point, a decline that’s continued even as growth for the current year looks unlikely to sustain that fourth-quarter pace.

Two Competing Explanations, Neither Fully Satisfying

Economists studying the disconnect have landed on a few competing explanations, none of which fully resolves the puzzle on its own. One theory holds that the economy’s actual potential growth rate is simply lower than standard models assume — meaning less growth is now required to move the unemployment needle than economists have historically expected, largely due to slower labor force growth coming out of this particular recession. A second, less charitable explanation for the falling rate points not to genuine labor market healing, but to people leaving the labor force altogether: workers who stop actively searching for jobs no longer count as “unemployed” in the official statistic, even though they still don’t have work. One widely circulated analysis found that if discouraged workers who’ve left the labor force were still counted, the “real” unemployment rate would sit above 11 percent — considerably higher than the headline figure being celebrated in this month’s release.

What the Falling Rate Actually Means for Workers

For workers navigating the job market directly, the gap between these competing explanations isn’t academic. If the falling rate genuinely reflects businesses hiring at a faster clip than sluggish GDP growth would predict, that’s a real, if fragile, positive signal — consistent with private-sector job gains that have, in fact, continued at a steady pace even as government payrolls have contracted in the same period. But if the decline is substantially driven by discouraged workers dropping out of the labor force count, the improving headline number risks masking a labor market that hasn’t actually gotten meaningfully easier to find work in — just harder to be counted as still looking.

Federal Reserve officials, for their part, have signaled they’re not fully convinced the recent pace of improvement will hold. Projections from Federal Open Market Committee participants continue to place the unemployment rate well above what they consider its longer-run natural level, and minutes from recent Fed meetings have cautioned that with growth expected to remain only moderately above potential in coming years, a full return to pre-recession unemployment levels could still be a long way off — a sober note underlying even the most encouraging monthly report.

For related coverage of the broader unemployment trend through this recovery, see our piece on January 2010’s confusing jobs report, or browse our full Labor & Economy archive.