Infocus - Why has the US unemployment rate stopped falling?

In this issue of Infocus, EFG Chief Economist Stefan Gerlach looks at the slowdown in the decline in the US unemployment rate and considers the difficulties facing the Fed which, by law, has to manage both employment and inflation.

Tension has developed between observers of US monetary policy and the Fed. While market participants and the public have worried about the recent rapid rise of inflation, Chairman Powell has repeatedly emphasised that the US remains some distance away from maximum employment and that it is premature to discuss reducing the degree of monetary accommodation.

The state of the labour market matters much more for the Fed 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. If so, with the unemployment rate more than 2% above that level, it appears that the US economy has still quite some way to run before maximum employment is reached.

While some commentators have been impatient for a sign that the Fed will soon start the long process of scaling back monetary policy, the Fed appears to believe that it is too early to do so.

Figure 1 shows the evolution of the US unemployment rate since late 2019. 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.

With the Fed concerned about ensuring maximum employment, the failure of unemployment to fall further will have direct implications for US monetary policy.

Why has the unemployment rate stopped declining?

But why has the improvement in the labour market slowed so drastically? Figure 2 provides one explanation. 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. By November, the proportion of workers on temporary layoff fell below 30% and started to decline slowly, falling below 20% only by May 2021.

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.

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