The Drop in the Unemployment Rate: A Bad Sign For the Economy?

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Economists are wondering why more people aren't lining up for jobs. (Shannon Stapleton/Reuters)

More jobs plus a lower unemployment rate equals — more to worry about. Really?

On Friday, the government reported that the job market grew faster in March than it has in that month for more than 5 years. The number of employed people in the U.S. increased by 216,000. That was better than the 194,000 jobs the economy added in February. And it was the third month in row that the economy created more jobs than the month before. The last time that happened, excluding government jobs added for the Census, was back in November 2005.

But the thing that surprised most economists and forecasters was this: The unemployment rate dropped, again, to 8.8%. Many forecasters had been predicting that the unemployment rate might rise this month. Instead it fell again for the fourth month in a row. In the past year and a half, the unemployment rate has dropped 13%, from a rate of 10.1% in October 2009. That’s one of the fastest drops in the unemployment rate of any recovery, and it is far faster than many expected. And, you guess it, that has some economists and forecasters worried. Here’s why:

You have to understand why economists have been expecting a jump in the unemployment rate, even as many continue to expect the economy to improve. That’s because the unemployment rate is a weird figure as this blog has written about in the past. It tracks not just the number of people without jobs but the number of people looking for jobs. If a growing number of people give up looking for work, even if the number of jobs doesn’t rise, the unemployment rate will drop. One of the things that observers have found curious about this recovery is that the number of people looking for a job even after the economy has improved has not spiked up. It rose this month, up 160,000, but over the past year it has basically been flat, even though the economy has improved.

So is this worrisome? Potentially, for two reasons. First of all, and this is a worry that people have had for some time, the amount of people out looking for work is a sign of how optimistic people are about the prospects of the economy, and their own prospects. Combine that with this week’s large drop in consumer confidence and that seems like a real worry. But there is a second newer fear raised by the fact that more people aren’t out looking for work: The Federal Reserve. If people don’t return to the workforce but companies continue to increase hiring that can cause inflation. The result may be that Ben Bernanke and the Fed would have to boost interest rates. And higher interest rates could slow the economy. Economy.com’s Mark Zandi on CNBC this morning said that the jobs report “calls into question when the Fed has to move on interest rates.”

James Paulsen, chief investment strategist of Wells Capital, though, says people are making a bigger deal out of the job market participation rate than they should be. The labor force has been growing slowly for some time. Women and baby boomers entered the workforce in droves in the 1970s. Since then the labor force has been growing much slower, a trend that has been slightly exaggerated during the recession, but a long-term trend nonetheless. “This isn’t a this recession phenomenon,” says Paulsen. “This is a 25-year trend.”

People are probably too worried about jobs growth causing inflation, as well. The March report showed that wages dropped slightly. So there is no real sign that employers have had to boost paychecks in order to lure workers. But even if the Fed was to raise interest rates, Paulsen doesn’t think that would be such a bad thing. He says two years into the recovery it probably no longer makes sense to have short-term interest rates stuck on zero. Paulsen says if the Fed were to raise interest rates, that would signal to others that the nation’s most important economists think the economy is finally improving. That would boost confidence and with it the recovery, perhaps more than higher interest rates would slow growth.

Lastly, Paulsen says we are probably too focused on the unemployment rate anyway. The thing we should be looking at is job growth, and that number was unambiguously better. What’s more, job growth is accelerating. Jobs in the private sector have grown by 1.6% in the past twelve months. But in the past three months, the rate has jumped to 2.1%. “That’s a huge move,” says Paulsen. “That’s the difference from having to worry about a double dip to widely accepting that this is a sustainable recovery.”

For me, I am not as worried that inflation is on the rise. So I don’t think the Fed will have to raise rates anytime soon. Rising job growth plus continued low interest rates equals great news. Goldilocks economy anyone? OK, not yet. But things are getting brighter for sure.

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