You'll no doubt recall that the Federal Reserve Board of Governors have tied changes in monetary policy to "substantial improvement in the labor market." In an Economic Letter for the San Francisco Fed , Mary C. Daly , Bart Hobijn , and Benjamin Bradshaw examine whether there are any signs of improvement. We begin by considering a wide array of data on labor market conditions in the United States. This includes information on employment, unemployment, the rate at which people quit existing jobs, the number of people who get hired, employers’ perceptions of the ease of filling their job vacancies, and workers’ sentiment about the state of the overall labor market. Because each of these series comes from a different source, comparing them requires putting them on equal footing in terms of how they’re measured. We do this by normalizing each indicator, as well as its 6-month change, to reflect how much it deviates from its own historical average at any point in time. In particular, we perform a statistical test by measuring how many standard deviations an indicator is from its historical average. The normalized six-month change in an indicator gives us a sense of whether it has a persistently strong correlation with the unemployment rate. We call this persistence number “momentum.” Finally, to make these data easier to compare, we transform them so they all move in the same direction over the business cycle. For example, the unemployment rate tends to decline when payroll job growth increases. To make job growth move in the same direction as the unemployment rate, we change its sign. We focus on the period from January 1978 to mid-2013. Our main interest is identifying those indicators whose movements over the past six months are most highly correlated with changes in the unemployment rate in the next six months. Because we are interested in the signals these data send about improvement in the outlook for the labor market, we calculate correlations over labor market expansions only, and do not include recessions. This is important because indicators that lead the labor market during downturns are not necessarily as informative during expansions. A prime example is the number of layoffs, which helps assess the depth of a downturn but is of little use in gauging the strength of a recovery. This is because the strength of recoveries is based on the rate at which people find jobs, which can remain low for some time after layoffs have subsided (Elsby, Hobijn, and Şahin, 2013). Among the 30 indicators we analyze, six stand out as excellent predictors of future improvements in the unemployment rate. Indeed, these six predict future changes in the unemployment rate better than lagged improvements in the unemployment rate itself. These indicators are the insured unemployment rate, initial claims for unemployment insurance, capacity utilization, the jobs gap, the Institute for Supply Management (ISM) manufacturing index, and private payroll employment growth. Among these common indicators, the jobs gap is the least familiar. Taken from the Conference Board’s Consumer Confidence Survey, it measures the difference between the percentage of households that considers jobs hard to get and the percentage that considers jobs plentiful. The six indicators are listed in Table 1 in order of their predictive power for future changes in the unemployment rate, as captured by the correlation between the indicators’ momentum, and changes in the unemployment rate during the subsequent six months. These correlations are printed in boldface in the second column of the table. The unemployment rate is listed in the first row for comparison. Comparing the first row with the other rows shows that the momentum of these indicators are all more closely correlated with the future change in the unemployment rate than the momentum of the unemployment rate itself. That is, when considering the speed at which the unemployment rate will come down, changes in our six indicators are better predictors than changes in the unemployment rate. This is precisely the value of these six momentum indicators. Read Gauging the Momentum of the Labor Recovery here .
Filed under: Federal Reserve, monetary policy, employment, labor market, San Francisco Fed, unemployed, economic letter, labor market conditions, Bart Hobijn, Mary C. Daly, Benjamin Bradshaw