How Did the Fed Conclude the Real Unemployment Rate Was 10% in January?
Official and Alternate Rates
The official unemployment rate as calculated by the BLS is 6.3%.
On February 10, I commented Powell Says the True Unemployment Rate is Actually 10%.
In response, an economist reader asked, "where is that chart from and how did Powell produce that blue line?"
The first question is easy. I linked to Powell's speech on Getting Back to a Strong Labor Market.
If you scroll down to the bottom there is a link to "View Speech Charts".
What is the Unemployment Rate?
Let's start with the basics that I am sure my reader understood.
The Unemployment Rate = Percentage of Unemployed People in the Labor Force
UR = (# of Unemployed / Labor Force) * 100
To be in the labor force you have to be employed or actively looking. The requirements for actively looking are strict. You have to send a resume or go on an interview. Reading Monster want ads is not sufficient.
From Powell's Speech
After rising to 14.8 percent in April of last year, the published unemployment rate has fallen relatively swiftly, reaching 6.3 percent in January. But published unemployment rates during COVID have dramatically understated the deterioration in the labor market. Most importantly, the pandemic has led to the largest 12-month decline in labor force participation since at least 1948. Fear of the virus and the disappearance of employment opportunities in the sectors most affected by it, such as restaurants, hotels, and entertainment venues, have led many to withdraw from the workforce. At the same time, virtual schooling has forced many parents to leave the work force to provide all-day care for their children. All told, nearly 5 million people say the pandemic prevented them from looking for work in January. In addition, the Bureau of Labor Statistics reports that many unemployed individuals have been misclassified as employed. Correcting this misclassification and counting those who have left the labor force since last February as unemployed would boost the unemployment rate to close to 10 percent in January (figure 6).
Powell asserts, and I agree, that millions of people the BLS says dropped out of the labor force are really unemployed.
Labor Force and Projected Labor Force
That huge drop in the labor force really represents unemployment but the strict questions of the BLS do not count them as such.
Q: Why the projection?
A: The labor force is a dynamic thing, generally growing over time at a near uniform rate recently, on average.
So, it's not just a matter of the initial loss, the Labor Force would have continued to grow and those jobs were lost too.
This impacts the numerator and denominator in the unemployment rate calculation equation.
Projected Future Labor Force Calculation
To project the Future Labor Force I went back 10 years looking for a slope that appeared uniform leading up to the Covid pandemic.
I selected 2016 as my base year. The month-to-month growth rate from January 2016 to February of 2020 is 0.000779378.
That does not sound like much but the labor force would have grown from 164.448 million to 165.863 million. Instead, the Labor Force fell to 160.161 million.
Based on those projections, and attributing 100% of the losses in the Labor Force to Covid led me to the following intermediate chart.
Unemployment Level in Thousands
The chart is starting to look familiar isn't it? But it shows unemployment levels, not the unemployment rate.
It's also missing something. Let's return to Powell's speech to see what.
"In addition, the Bureau of Labor Statistics reports that many unemployed individuals have been misclassified as employed."
To find that data one has to look at individual month-to-month BLS job reports. I went through the archives and came up with this.
Admitted BLS Error Rates
- January: 0.00%
- February: 0.00%
- March: 1.00%
- April: 5.00%
- May: 3.00%
- June: 1.00%
- July: 1.00%
- August: 0.70%
- September: 0.40%
- October: 0.30%
- November: 0.40%
- December: 0.60%
- January: 0.60%
Let's look at a snip from the BLS Archive for May 2020.
As was the case in March and April, household survey interviewers were instructed to classify employed persons absent from work due to coronavirus-related business closures as unemployed on temporary layoff. However, it is apparent that not all such workers were so classified. BLS and the Census Bureau are investigating why this misclassification error continues to occur and are taking additional steps to address the issue.
If the workers who were recorded as employed but absent from work due to "other reasons" (over and above the number absent for other reasons in a typical May) had been classified as unemployed on temporary layoff, the overall unemployment rate would have been about 3 percentage points higher than reported on a not seasonally adjusted basis.
However, according to usual practice, the data from the household survey are accepted as recorded. To maintain data integrity, no ad hoc actions are taken to reclassify survey responses.
To maintain data integrity, the BLS reported an unemployment rate of 14.8% in April instead of 19.8%.
In May, the BLS reported 13.3% unemployment instead of 16.3%.
Although the BLS reported the error, few saw it. Thus, we have data integrity but reporting nonsense.
Combining the Pieces
- Take the BLS published unemployment rate (or calculate it). I did the latter as a check and my calculation matched the BLS' published rate.
- Plot the labor force and what it would have been without Covid.
- Calculate the additional number of jobs that were really lost based on Powell's labor force discussion.
- Calculate a labor-force factored unemployment rate also based on Powell's methodology of jobs lost.
- Add in the BLS admitted error rate.
Unemployment Rate and Alternate Rates
When I started this exercise I guessed (wrongly) that Powell did not factor in a dynamic labor force. I set out to show what it should be with a column for Mish Alternate.
It turns out my proposed alternate was what Powell did or appears to have done.
Without factoring in a dynamic labor force led to an initial plunge of 25% not 24%, the slight dip in October is missing, and the current estimate now would be about 9%.
April 2020 Flashback
On April 6, 2020, I asked and answered How High Will the Unemployment Rate Rise in April?
Estimated Unemployment Rate
(7.14 million current + 27.9 million new) / 162.91 million labor force = 21.5%.
I was a bit surprised by the reported 14.8% but if one adds in the 5 percentage points of admitted BLS errors, one would have arrived at 19.8%.
In retrospect, it turns out I was an optimist.
Errors and Assumption in the Current Model
- I arrived at 10.15%. Powell said "close to 10%". How close? I suspect I am a tiny bit high in my month-to-month labor force growth factor.
- Powell assumes 100% of the decline in the labor force represents unemployment due to Covid.
- Powell also assumes there would have not been a recession. That was not my assumption at the time but it was widely believed.
- At some point, and it is impossible to know when, the rate of growth in the labor force would have changed if for no other reason than changing Boomer demographic dynamics.
The Fed's Solution
I agree with Powell that the unemployment rate is understated, but vehemently disagree with the Fed regarding what to do about it.
Specifically, the Fed is hell bent on producing more inflation.
The Fed does not have any idea how to measure inflation and is ignoring bubbles with a misguided focus on the CPI rather than inflation.
Despite clear asset bubbles, the Fed says Monetary Policy Will Stay Accommodative For a Very Long Time.
Translated, that means forever or until a global currency crisis changes their tune.
Last year I wrote an open letter to Powell regarding the CPI.
Please give Hello Jerome Powell, We Have Questions a read.