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The Unemployment Rate Isn’t Used to Keep Unemployment Low (With Graph)

2016 February 17
by Ian Welsh

Years ago, I complained to my friend Stirling Newberry that the unemployment rate didn’t seem to track how good the economy felt, or how many people were in desperate need  of employment.

The unemployment rate was, then, and is now, taken as a proxy for the health of the economy for ordinary people. However, I could see and feel that the economy was getting worse for ordinary people, and that fact was showing up in other statistics. Plus unemployment rates which were considered a crisis when I was young in the 70s, were now being considered acceptable.

(See: The Economy Has Not Recovered, With Graphs)

Stirling said, “You need to know who an economic statistic is designed for, and what they use it for.”

A little history is necessary here, about inflation. In the 70s, due to the oil crisis and other mishandled economic problems, inflation got out of control in the West. Very high interest rates were used to bring it down, by Chairman Volcker at the Fed.


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Western policy makers became obsessed with inflation. It was considered enemy Number One. They decided that the worst cause of inflation was wage increases and called this “wage push inflation.”

To track this, they turned to a statistic called the non-accelerating inflation rate of unemployment (NAIRU). NAIRU was the rate below which the unemployment rate was assumed to cause inflation.

The unemployment figure measures the number of people actively looking for jobs, compared to those who have jobs, remember. Thus it measures the active demand, in the market, for a job. Therefore, theoretically, if there are too few people looking for jobs, employers are expected to have to raise wages to attract workers.

(This is, to be clear, when wages rise the most, which is something non-economists and non-oligarchs want to happen.)

If you are old enough, you will remember that during the 80s and 90s, and even into the 00s, when the unemployment rate would drop, the stock market would take losses. This is because stock investors expected the Federal Reserve to raise interest rates, which is bad for the economy and bad for stocks.

So, the unemployment rate from late 70s and on, has been used to determine if wages should cause inflation, and to then raise interest rates to make sure they don’t.

Not incidentally, the result is also to crush wages, because, essentially, wages that improve are nothing more than wages that increase faster than non-wage inflation.

The unemployment rate not only doesn’t measure how good the economy feels for ordinary people, it was actually used, with purposeful action, to crush wages.

You’ve all been waiting patiently for your pretty graph, so here it is.

NAIRU vs Unemployment vs Fed Funds

NAIRU (Civilian Unemployment Rate) vs Unemployment (Natural Rate of Unemployment) vs Effective Federal Funds Rate

You’ll notice that while effective federal funds rates (the green line) increase during low unemployment periods (the red line) before Volcker, it is after Volcker that they correlate strongly to whether the unemployment rate is approaching or below NAIRU.  Before Volcker, the unemployment rate is often below NAIRU and people get a lot of raises.

Note, in particular, and with amusement, that the flat, blue line rate (the natural rate of unemployment) in recent years shows a period where unemployment has stayed above NAIRU. Note that Yellen started talking about increasing rates as the unemployment rate came closer to NAIRU.

Your wages were crushed, deliberately, supposedly to crush wage inflation.

And this is why unemployment doesn’t have very much to do with how the economy feels for ordinary people, especially not now (it effects how the economy feels some, but not much). Unemployment has to get below NAIRU and stay there for you to get real wages.

I will point out, for completeness, that the idea that wages are the most important source of inflation is questionable, but I’ll deal with that at a later date.

(Read: A more detailed look at the end of the post-war Liberal Era)

 

8 Responses
  1. S Brennan permalink
    February 17, 2016

    Good Post Ian;

    I mention in passing, [because you already know], Jimmy Carter elevated Paul Volker, NOT REAGAN. Until the left understand what happened in the 70’s they are powerless.

  2. Greg T permalink
    February 17, 2016

    There are many economic sectors where inflation is high that has nothing to do with higher wages. Education, particularly higher education is one example. Inflation has been running at7% since at least the mid-80s. Health Care is another. Inflation rates are about the same over a similar period. Cell phone service is inflating at an insanely high rate. The list goes on.

    That never seems to show up in inflation measures.

  3. Spinoza permalink
    February 18, 2016

    “Natural Rate of Unemployment”…what a revealing turn of phrase.

  4. February 18, 2016

    In the UK the situation has been complicated by the government’s determination to reduce the cost of welfare, which has led to lots of people being reclassified as self-employed when in fact they are not earning a penny. Lots more have been sanctioned off benefits because they failed to look hard enough for jobs which weren’t there. So we have an apparent unemployment rate pretty much on NAIRU, but no sign of inflation and tax revenues well below forecast!

  5. EmilianoZ permalink
    February 18, 2016

    There was a very interesting post at NC that said that the main purpose of a large unemployment rate was to discipline the workers. Employers usually find that they cant effectively discipline their workers when they can just leave and get another job. The post went on to say that there’s only one condition under which employers would tolerate full employment: when the workers are disciplined by fascism. That was a post about Trump.

    Unemployment has plenty of useful features for our lords and masters.

  6. February 18, 2016

    It is funny that having lived in Alberta where recently we really did have a 4% unemployment rate we had the following:

    -help wanted signs everywhere
    -new university graduates from around the country
    -people getting raises and bonuses at all income levels in all types of jobs
    -long waits for anything involving a trade
    -lousy service in fast food places
    -lots of mobility upwards – last weeks busboy is today’s waiter is tomorrows manager
    -people making enough money to live their dreams

    This type of activity was noticed everywhere. You had things like the City of Edmonton not performing maintenance because there were not people available to perform the work.

    During my travels to the US Cities where the unemployment rate is supposedly 4% I have never noticed the broad based boom like in Alberta. Maybe I did not go to the right places, and the plural of anecdote is not data, but there should be some outward signs of a tight labor market.

    Unfortunately us Albertans will not have to worry about this until the next boom. In the meantime the last person out will get to turn the lights out…….

  7. Hugh permalink
    February 18, 2016

    What S Brennan is referring to is that Carter not only appointed Volcker but the following also occurred during his Presidency:

    1978 Airline Deregulation Act deregulating the airlines
    1978 Civil Service Reform Act set up the Federal Labor Relations Authority to oversee collective bargaining with federal workers. It was this entity which Reagan used to decertify Patco in 1981
    1980 The Depository Institutions Deregulation and Monetary Control Act repealed usury limits on what banks could charge in interest
    Motor Carrier Act of 1980: deregulated trucking

    When I chart the foundation and construction of the present kleptocracy, this is why I place its origins in the Carter Administration.

    Ian is correct that since Volcker the primary mission of the Fed has been to crush wage growth and it has been very successful in doing so. As productivity increased since this time and real wages did not, the wealth that increased productivity represented flowed, not to workers but the 1%, and represents one of the largest transfers of wealth in history.

    The Fed was not, however, the only agent of this theft. The destruction of unionism was also important. I track the demise of unionism back to the Red Scares of the Wilson (a liberal) era which effectively cut unions off from the larger social movements which fed and protected them and were necessary for their long-term survival. It took decades, but with their broader social activism gone, they became institutionalized, and ossified This allowed them first to be isolated, challenged and then destroyed. You have only to look at the SEIU endorsement of a pro-corporatist candidate like Hillary Clinton or the waffling and ineffectuality of Trumka to see just how far unionism has fallen and betrayed itself.

    Then there is offshoring. Why raise the pay of an American worker, when you can send her and his job to China, Vietnam, or Bengladesh, abuse the workers there more and pay them much, much less? Sure, the quality (and often the safety) control goes to hell, this is why the new normal is a flood of cheap, crappy, and sometimes dangerous products, but an added plus is that the threat of offshoring helps depress wage increases for jobs that aren’t (or haven’t yet) been exported.

    Finally, there is inshoring. It says so much about the decadence of our times that the billionaire Trump rants against illegal immigration when so many of those who built his grandiose monuments to the rich and staff them are the very illegals he rails against. Whole sectors like agriculture, meat packing, hotels, restaurants, and construction depend on illegals. Again these workers can not only be paid less and treated worse than American workers. They also have a depressive effect on wages of Americans still in these industries and more broadly on wages in the economy in general. Trump doesn’t need to build a wall alog the Rio Grande. All he needs to do is heavily penalize the employers of illegals, you know, like himself.

  8. Billikin permalink
    February 19, 2016

    “To track this, they turned to a statistic called the non-accelerating inflation rate of unemployment (NAIRU). NAIRU was the rate below which the unemployment rate was assumed to cause inflation.”

    The NAIRU is not a statistic. It has never, repeat, never been measured, or shown to exist. If the unemployment rate falls below the supposed NAIRU, it is supposed to cause not only inflation, but accelerating (hyper) inflation. That is patently absurd. You have to make some ridiculous assumptions to think that.

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