To understand Federal Reserve policy, one must understand the labour market.
When hiring strengthens to the satisfaction of a critical mass of the 19 men and women who help set policy, tapering of asset purchases will begin, and the walk to normal with it.
But that’s precisely why Fed policy has become so confusing to so many – there’s no clear barometer of the labour market’s health.
The unemployment rate is the highest profile jobs indicator. But, as Fed chairman Ben Bernanke acknowledged Wednesday, a problematic one. The jobless rate has fallen in part because fewer people are looking for work. That exaggerates the amount of actual hiring that is taking place.
“There is a cyclical component to participation,” Mr. Bernanke said at a press conference. “The unemployment rate understates the sort of true unemployment, if you will, in the economy.”
This isn’t a new observation. In fact, the unemployment rate is broadly dismissed for this very reason. The participation rate was 63.2 per cent in August, compared with 63.4 per cent in July and levels that exceeded 66 per cent before the recession. A shrinking participation rate isn’t a sign of a vibrant economy.
Still, it’s possible the participation rate overstates the weakness. That’s what Mr. Bernanke thinks, anyway.
The August rate was three-tenths of a percentage point lower than it was a year ago, and the unemployment rate – 7.3 per cent – was eight-tenths of a percentage point lower than when the Fed started its third round of quantitative easing.
That relationship is “pretty much trench,” Mr. Bernanke said.
“In other words, I think it would be fair to say that most of the improvement ... not all, but most of it, is due to job creation rather than too little participation,” Mr. Bernanke said.
There are other non-economic reasons that the participation rate is falling.
More men and women are retiring as the population ages, for example. Women are joining at the same rate as they did in the past because they’ve closed the gap that existed after the Second World War. Younger people are going back to school. That could have something to do with a weak economy, but that’s different than languishing on the sidelines.
Mr. Bernanke noted that part-time workers, discouraged workers and other indicators have fallen proportionately with the decline in the unemployment rate.
Bottom line: The unemployment rate is an imperfect indicator at the moment, but far from a useless one, at least in the eyes of the boss at the Federal Reserve.