The state of the labour market matters much more for the Federal Reserve than other central banks because by law the Fed has dual objectives of price stability and maximum employment. While the latter term has not been defined, Chairman Powell has mentioned that the low unemployment rates of less than 4% observed before the Covid pandemic arguably constituted maximum employment.
The unemployment rate was 3.5% in February 2020 but started to rise precipitously in March as the pandemic took hold. It peaked at 14.8% in April, but then started to decline rapidly, falling by almost 8% to reach 6.9% in October. Since then, the rate of decline has slowed dramatically, and it took until May 2021 for the unemployment rate to fall below 6%. It was 5.9% in June.
But why has the improvement in the labour market slowed so drastically? After the pandemic started, the fraction of unemployed workers that were temporarily laid off rose rapidly from 13% to 78%. These workers remained in contact with their former employers with the understanding that they would be asked to return to their jobs as soon as the economy reopened.
As the economic recovery set in, these workers quickly returned to their jobs and the unemployment rate collapsed. With the group of temporarily laid-off workers contracting, the group of “other” workers – comprising new entrants to the labour market such as students, re-entrants such as those that gave up looking for a job when the pandemic started, and job leavers/quitters – grew in importance.
Job finding rate and the separation rate
The traditional view of the unemployment rate is that it reflects the balance between two forces: the job finding rate and the separation rate. The first of these captures the fraction of unemployed workers who find a job in any given month; the second captures the fraction of employed workers who leave their job. This separation often arises because workers are made redundant. But it can also occur because they chose to move to a different location, decide to return to school or to retire, or to search for more attractive employment.
To see the importance of quits, it is helpful to look at the numbers of workers – currently employed or unemployed – hired and who “separate” from a job in each month. The total number of hires has exceeded the number of workers separated from their jobs in the first four months of this year, but only marginally. This is why the unemployment rate has fallen so slowly.
But the figure also shows that two thirds of workers separating from their jobs are simply quitting. Apparently, workers think that the reopening of the economy after Covid offers a particularly good time to look for a better job.
If these factors prove long-lasting, it may be that the unemployment rate will continue to decline slowly. If so, it is possible that the Fed will indeed be slow to reduce the degree of monetary accommodation. But it may also be that these phenomena are temporary, and the unemployment rate starts to fall more rapidly again. If so, the Fed is likely to bring forward the starting dates of tapering and interest rate increases. It will therefore be important to monitor the incoming labour market data.
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