A Falling Unemployment Rate Can Be Misleading

The unemployment rate fell in June to 9.5% from 9.7%, reaching its lowest point since last July. But the decline wasn’t due to improvement in the labor market. Instead, jobless Americans dropped out of the labor force in droves.
June’s decline in the civilian labor force of 652,000 was the sharpest one-month decline in 15 years in the Labor Department’s survey of households. Some people could be frustrated with their job searches, choosing to take time off or pursue other options like school. Some could be experiencing the end of their unemployment benefits, which required them to maintain an active job search. Whatever the cause, over the past two months almost one million people simply stopped looking for work. And over those two months, the U.S. population grew by 361,000 — with more than half of that gain coming in June.
The drop of 125,000 jobs in the monthly payroll report, which is compiled from a separate survey of employers, should have led to an increase in June’s jobless rate. The economy generally needs to add at least 100,000 jobs a month — often more — just to keep up with growth in the labor market and keep the unemployment rate steady. In June, people giving up hope and leaving the job market offset that need for more jobs to keep the jobless rate even.
What happens when all those people return? The unemployment rate is a measure of the total number of unemployed people — defined as those out of work but looking for work — as a share of the overall labor force. Once the economy improves, many of those people will restart their job searches and expand the labor force again.
If employers aren’t producing enough jobs to satisfy all that available labor — they probably won’t be — then the overall unemployment rate will rise again. The recent drops in consumer confidence and the recent pace of hiring suggests many Americans won’t be rushing back into the job market soon. That will mean continuing downward pressure on wages — and little underlying inflation.