Unemployment numbers for November were released today. The unemployment rate hit 7.0 percent for the first time since November 2008. If your recent economic history is a little fuzzy, that’s right about the time the banking crisis and housing market implosion was a full tilt. In other words, we’ve been over seven percent unemployment since the so-called Great Recession started.
I get a lot of questions about economic news stories. In particular, people want to understand the significance of the various economic statistics that come out better so that they can separate real new from hyperbole. So, let’s take a look at these unemployment numbers and see what the deal is.
What Is the Unemployment Range?
First, off, it can be hard to overstate how important unemployment (or more accurately, employment) is to the overall well being of the economy. I’ve covered before what makes unemployment numbers so important, so we’ll leave that out for today and focus instead on what is going on here, and why it matters so much.
One question I get from time to time is why people get so excited over small movements in the numbers.
That’s a good question.
It can help to have some context for the range of unemployment numbers. Theoretically, unemployment could range from 0% to 100%. However, in the United States (things are very different in other countries with different political and economic systems) there is historically a rather small range of unemployment. If you take a look at this chart, you’ll see that the unemployment rate dropped under 3% very briefly back in the early 1950s. If you know your history, you’ll know that time period corresponds with the end of World War II. That means fewer workers (sorry) and an expanding post-war economy. That number is never touched again.
Instead, something in the 4 percent range is really the bottom of the numbers for the unemployment rate, and this isn’t exactly common. Typically such low unemployment comes only in times of serious economic expansion, and such a low rate is considered inflationary, meaning that prices are being driven higher by “over-employment.”
Conversely, you’ll see that 10 percent unemployment marks the upper limit of the range. Again, such numbers are not common. The first 10 percent peak occurs in the early 1980s. This recession was composed of two big factors, first, an overzealous Fed cranking up interest rates too quickly in order to stop inflation (avoid this type of scenario is a cornerstone of today’s Fed), second, the collapse of the Savings and Loan industry.
Yes, a banking crisis caused the previous Great Recession (although no one called it that) as well.
The second 10 percent hit occurred recently at the height of our current Great Recession which was caused, in part, by the Fed raising rates to combat inflation, which led to the collapse of the housing market, and another banking crisis.
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What Is Normal Unemployment?
Talking about normal unemployment is a little bit like talking about normal weather. Just because something is normal, doesn’t mean it is the same. A normal temperature in Denver in July is well above 80, while a normal temperature in December is much lower. Furthermore, even in a single month a range of temperatures is considered normal.
Much like the weather, the economy has cycles of boom and bust as well. Theoretically, if anyone ever got economic conditions exactly right, an equilibrium could be achieved between growth and contraction, but that isn’t how the real world works.
The reason a “little” change in unemployment rates are such a big deal, is because the overall range is so small to begin with. At it’s biggest the possible range, unemployment is from 2.5 percent to 10 percent, for a total range of 7.5 percent. Thus a single percentage point change in the unemployment rate represents a movement of 13 percent within the scale.
In looking at the chart, you can see that more “normal” unemployment typically ranges between 4 percent and 7 percent. That represents just a 3 percent range of unemployment. Each full-percentage movement is therefore a HUGE change in the status of the nation’s unemployment rate. That is why every 0.1 percent change is such a big deal.
Why is there never zero percent unemployment?
Since the economy is not stagnant, nor are companies or people, the concept of zero percent unemployment is not really something for the real world. Some jobs are seasonal, people retire, people move, and so on. If literally everyone were employed (zero percent unemployment), it would be impossible to create another job. So the goal of economic policy is not zero percent unemployment.
What is the Best Unemployment Rate?
Economics is not an exact science. The concept of what the best unemployment rate for America is open to debate. That’s real, data-driven, debate between educated scholars, not just political debate. Generally, there is an accepted convention that employment somewhere around 5.0 percent and 5.5 percent is neutral to the overall economy. That is that anything less than that would be inflationary, while anything higher is not. So, the goal, in so far as there is one, is for an ideal unemployment rate around 5 percent. At that rate, everyone who wants a job, that they are qualified for, in the season in which the job exists, can get one.
So, at 7.0 percent, today’s unemployment rate is hardly what anyone wants it to be. On the other hand, the move from 8.0 at the beginning of the year, to 7.0 near the end of the year, is a huge move in the right direction.
Stock Market Reaction to the Unemployment Rate
Remember that the stock market is a leading indicator. That is, that it’s direction is predictive of future economic events. So, every move in the markets is the best guess of all market participants about where the economy is heading, not where it is now.
A lower unemployment rate is good news. It means the economy is generating jobs and people will have more money to spend. On the other hand, a lower unemployment rate means the economy will eventually need less help from the Fed, which may choose to raise interest rates, or in today’s case, start tapering some of the economic stimulus it has been providing in the absence of Congress’ ability to do anything to help.
This on the one hand, on the other hand, concept explains the almost schizophrenic reaction of the stock market to employment news. If employment is good, then the economy is good and stocks should be higher. But if employment is too good, the maybe the economy is too good and this bad, and the stock market should be lower.
As always, predicting day to day movements of the stock market is a sucker’s game. For now, lower unemployment is very good news for the economy. If and when the Fed decides it’s time to ease up on the stimulus the markets will react negatively in the short-term. But, if the economy keeps improving, even with the removal of stimulus, then the markets will follow. Don’t get whiplash in between.
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