Monday, February 10, 2014

Falling US Unemployment and Interest Rates

The goals of monetary policy as spelled out in the Federal Reserve Act which specifies that the Board of Governors and the Federal Open Market Committee should seek “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Therefore, the unemployment rate is considered to be one of the key gauges that the Federal Reserve (Fed) monitors closely. The US unemployment rate is calculated based on a survey administered by the Bureau of Labor Statistics.

The US unemployment rate has fallen steeply and it has taken some Fed officials by surprise.  One of the reasons for a steep fall in unemployment is the exodus of millions of workers. Job-seekers have quit looking for work because of various reasons such as retirement, enhancing skills through education, joining disability, or simply quit looking for work. Nearly 8 million part-time workers want full-time work and another 2.4 million workers want jobs but are not pursuing any opportunity. If you add these people to the unemployed pool the jobless rate jumps from 6.7% to 13.1%.

The latest household and establishment reports released by the Labor department shows that the unemployment rate ticked down to 6.6%. After seasonal adjustments US employers added 113,000 jobs. The drop in unemployment could also be attributed to the expiration of the federal jobless benefits. Those whose jobless benefits ended could have dropped out of the employable workforce and some of those settled for jobs that they would have passed over because they still had jobless benefits. However, it seems that the drop in the unemployment rate could be attributed to the latter. Economists predict that without jobless benefits the unemployment rate could further fall to 6.4% by June.

How does the Fed factor this latest information in setting interest rates? Since 2012, the Fed has maintained that they will not consider raising short term rates until unemployment rate falls to 6.5%. Recently, they have said that they will weigh in other factors such as under-employment rate, wage growth and so on. So far the falling unemployment rate has not triggered a strong wage growth or inflation. Therefore, we can reasonably believe that the Fed will wait until all indicators align to start increasing short-term interest rates, which could be why the stock markets shrugged off the jobs report. The Dow Jones Industrial Average climbed 1.1% or 165.55 points on Friday.

Source: The following report was summarized from the following WSJ articles -
1. “Slow Jobs Growth Stirs Worry”, Feb 7, 2014.
2. “Rate Decision to Drive Yellen’s Early Agenda”, Feb 2, 2014.
3. “The Downside of Lower Unemployment”, Feb 2, 2014.

Dr. Subramanian “Subbu” Rama Iyer is an assistant professor of Finance at UNM Anderson School of Management.  Click here to contact Dr. Iyer.

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