ECONOMICS: US PERSPECTIVES—JANUARY 14, 2011

Sharp Decline in US Unemployment Rate:

Inflection Point or Misleading Signal?
Joseph G. Carson
US Economist and Director—Global Economic Research, (212) 969 6886

December’s unemployment data were widely dismissed as a sign Display 1

Exceptional Drop in US Jobless Rate
of improvement because part of the drop was driven by a reduc-
Change in the Civilian Unemployment Rate
tion in the workforce. But large declines in the jobless rate are Percentage Points

rare and the similarity of the recent data to other comparable 0.6

periods suggests that the US labor market is beginning to heal. 0.4

When the unemployment rate fell sharply the recent improvements. History shows 0.2

in December, many analysts dismissed the
decline as a statistical quirk, even though it
was one of the biggest improvements ever
recorded. The civilian unemployment rate
fell 0.4 percentage point (Display 1) to
9.4%, according to the Bureau of Labor
that large swings in the unemployment
0.0
rate are often significant indicators of
change. Over the past 40 years, the (0.2)
unemployment rate has only risen or fallen
by at least 0.4 point in 22 individual (0.4)
months. Of those, 17 months were cases 2009 2010

Statistics, with half the drop attributed to
more people working. But the remainder
was the result of a decline in the labor
force, which some observers interpreted as
a sign that an increasing number of people
had given up looking for work.
It’s true that the composition of the fall in
the unemployment rate was split between
employment gains and labor force
declines. In December, 297,000 people
found jobs, but at the same time the
workforce declined by 260,000, according
to the Household Employment Survey. It’s
impossible to determine why people opted
to stop seeking jobs, as movements in and
out of the labor force are volatile.
However, we think the mixed signals
should not detract from the importance of
of rising unemployment, while only
five—including December—were declines.
Good Intelligence in Rate Change
During each month when the unemploy-
ment rate rose by more than 0.4 point,
the increase sent a clear signal that either
an economic recession had already begun
or that labor market weakness would
soon trigger incremental job losses and
even higher jobless rates. Most impor-
tantly, however, it was the change in the
jobless rate and not the change in
underlying factors such as employment or
the labor force that offered the most
accurate economic intelligence.
For example, in May 2008 the jobless rate
increased by 0.5 percentage point from
4.9% to 5.4%. Most of this gain was
As of December 2010
Source: Bureau of Labor Statistics and Haver Analytics
prompted by a very large expansion of the
labor force, which at first led us to
downplay the deterioration in the jobless
figures. In fact, even though the sharp
gain in the unemployment rate was
dominated by more people looking for
work, it turned out to be a telltale sign
that underlying economic conditions were
weakening and the US economy had
become increasingly vulnerable to shocks.
Since 1970, there have been only five
occasions—including December
2010—when the jobless rate dropped by
0.4 percentage point or more. Since there
have been so few comparable declines,
we took a closer look at each case to
see if we could distill any common
characteristics.
In two cases, the unemployment rate was
at nearly 10% and the economic recovery
had just begun, such as in 1983. In the
other two cases, in 1996 and 1998, job
More Evidence of a Turning Point
Importantly, there is additional evidence Display 2
arguing that the labor markets are near a Big Companies Report Record Hiring Plans
turning point. For example, hiring Percentage Increase in Employment in Six Months
intentions of executives increased sharply
50
to a record in the fourth quarter, according
40
to the Business Roundtable CEO survey.
(Display 2). Meanwhile, hiring intentions 30

and economic growth was relatively
robust. Most importantly, in all four cases,
the sharp declines in the jobless rate were
driven in part by a reduction in the labor
force, while the average size of the decline
in the labor force was identical to the
decline of December 2010.
This doesn’t mean that the next employ-
ment report will show a relatively large
gain in jobs and a further decline in the
jobless rate. In fact, in the past, the
unemployment rate ticked up by 0.1 point
in more than half the months immediately
following a sharp fall of at least 0.4 point
Percent
of small businesses reached a two-year 20
high in December, according to the
10
National Federation of Independent
0
Businesses (Display 3).
02 03 04 05 06 07 08 09 10
We think there is ample evidence to As of December 2010
Source: Business Roundtable and Haver Analytics
support the view that the sharp fall in the
jobless rate in December 2010 to a
30-month low was an inflection point Display 3
rather than a statistical fluke. Indeed, Small Firms Are Also Hiring Again
history says the most important early Percentage of Small Businesses Planning to Hire
signal from the labor markets is the change
12
in the unemployment rate, and not the
8
granular data on job growth or labor force
4
changes. Changes in the unemployment

Percent
0
in the jobless rate. But the sharp falls in rate tell us something about underlying
(4)
the jobless rate were inflection points, shifts taking place in labor markets and the
(8)
that signaled sharp declines in the jobless general economy. In our view, those
(12)
rate and large gains in employment in changes—positive or negative—will
2008 2009 2010
1983, or continued low rates of unem- become clearer in coming data reports, but
ployment and strong job growth in 1996 the general trends indicate that the US As of December 2010
Source: Haver Analytics and National Federation of Independent
and 1998. labor market is healing and job growth is Business
poised to pick up. n

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JANUARY 14, 2011 ECONOMIC PERSPECTIVES