The guest commentary below was written by Dr. Daniel Thornton of D.L. Thornton Economics.
The unemployment rate hit 3.9% in April, the lowest rate since December 2000. Many believe that this feat was due in large part to the Fed’s monetary policy. The truth is we really don’t know how much, if any, is attributable to the Federal Open Market Committee’s (FOMC’s) monetary policy. But it surely shouldn’t get all the credit. In fact, it is possible it doesn’t deserve any. This essay explains why.
The unemployment rate is calculated by the Bureau of Labor Statistics. There are two measures that are important in understanding the unemployment rate. The first is called the Civilian Noninstitutional Population (CNP), which is defined as the number of “persons 16 years of age and older residing in the 50 states and the District of Columbia, who are not inmates of institutions (e.g., penal and mental facilities, homes for the aged), and who are not on active duty in the Armed Forces.”
The second is the labor force, which is defined as those of the CNP that are working or actively seeking work. The labor force participation rate (LFPR) is the percent of the CNP that are in the labor force. To be included in the labor force one must be working or actively seeking work. Those in the CNP who are not working or looking for a job are not in the labor force.
The unemployment rate is simply the percent of the labor force (LF) that are employed ( emp ). Mathematically the unemployment rate, ur, is expressed as,
Hence, the unemployment rate can fall either because employment increases or because the labor force declines, i.e., the LFPR declines. The graph shows the LFPR since 1948. The LFPR increased steadily from the mid-1960s to early 2000. Much of this increase was due to a marked increase in women in the labor force. The LFPR declined slightly following the 2001 recession, but dramatically after the last recession. The participation rate fell from 66 percent in December 2007, the start of the recession, to 62.8 percent in April 2018.
One way to see how much of the reduction in the unemployment rate was due to monetary policy is to see what the unemployment rate would have been in April 2018 if the participation rate had remained at 66 percent.
In April the CNP was 257,272 thousand. If the labor force participation rate was 66 percent, the labor force would have been 169,799 thousand. The unemployment rate would have been [1 – (155,187/169,799)] = .086, that is, 8.6%. Hence, much of the decline in the unemployment rate to 3.9% is due to a dramatic, yet unexplained, decline in the LFPR.
There is other evidence to suggest the FOMC should not get too much credit. Specifically, post -recession employment growth since the last recession is the second lowest in history; the lowest occurred after the 2000 recession. This is shown in the figure below, which shows employment growth after each of the post-war recessions.
Hence, no one really knows how much of the decline in the unemployment rate is due to the FOMC’s monetary policy, but it surely shouldn’t get all the credit. I’ll go on record as saying it doesn’t deserve much of the credit (I’ll have more to say about this in my next essay).
EDITOR'S NOTE
This is a Hedgeye Guest Contributor piece written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.
