Metal figures, upper body and heads of men, standing in a line

Source: Excerpt of “Breadline 2“ by Peter Griffin, on PublicDomainPictures.net

Uh oh! The unemployment rate has gone up three months straight. Does that mean a recession is around the corner? It might be.

Economists, journalists and investors look at the official unemployment rate to judge the state of the economy. But as with any other recession indicator, you can’t take this single number at face value either.

In short

  • The official unemployment rate has a good track record as a lagging recession indicator.
  • That is in good part because when economists look back to officially declare a recession they look at unemployment.
  • For the United States, the official unemployment rate U-3 excludes a range of people not in full-time employment, for example part-time workers, or those who have not recently looked for a job. You get a more complete picture by looking at U-6.

Economy and official unemployment rate

When the unemployment rate is rising, headlines and newsanchors are quick to shout: recession!

That’s because there is an obvious link between employment and economic activity: if the economy is doing well, jobs are created. If it suffers then companies go out of business and people get fired.

So, when more and more people become unemployed, people are quick to shout: ah crap, economy is nose diving! A recession is coming! In the same way, unemployment staying historically low in summer 2022 had many people doubt that a recession was imminent.

But, unemployment is of course important in a much more fundamental way: it’s about jobs, incomes, and livelihoods—it’s one of those topics that decides elections. And that’s where the problem comes in with “official” unemployment rates: politicians have every interest in keeping that headline number low.

There are two ways that the government can “fix” unemployent: fire up the economy or—if that doesn’t work—count unemployment differently.

So, if you want to use the unemployment rate as a recession indicator, it pays to have a closer look what the official statistic actually means. We’ll do that below.

Does it work?

Yes. If the unemployment rate shoots up there is a recession around. Have a look at this picture, showing the official unemployment rate for the United States since 1948. The shaded areas are recessions. As you can see, that matches. But that’s not surprising.

12 recessions since 1948. During each the unemployment rate rises significantly. Notably, after the 1990 recession, the unemployment rate kept rising for another year or so

Source: U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, November 16, 2022.

It’s not very surprising because many central banks and institutes, including the [United States' NBER]({{ relref “/what-is-recession/index.md#nber” }}), use unemployment to determine a recession. That means, unemployment is part of the [official definition of a recession]({{ relref “/what-is-recession/index.md” }}) (even if not the technical definition that talks about shrinking GDP).

Leading or lagging?

How useful is the unemployment rate at predicting a recession?

Not that great. For the unemployment rate to move a lot, bosses need to decide to let people go on a large scale. Or things need to be so bad that companies shut down entirely. So, that’s a bit late in the game—which is why economists call unemployment rate a lagging indicator for a recession.

Typical headlines

Here are headlines linking employment rate to recessions:

Here is OregonLive referencing the broader unemployment rate U-6, here as “underemployment”: Oregon ‘underemployment’ rate hits a record low – but there’s a downside

United States: The official unemployment rate, U-3

Official unemployment rate for the United States: U-3

The official unemployment rate in the United States looks at the labor force and asks: how many people of them are unemployed? Sounds reasonable, right? Now, here is the trick: You’re only unemployed if you can and want to work, and if you have been looking for work in the past four weeks.

Now, that conveniently excludes people and hides problems.

Who is and isn’t counted by U-3?

Let’s say you’re looking for a job but after looking far and wide you just can’t find anything. You take a break from the job hunt for a month and … a miracle happens! You’re no longer unemployed! And one more: you’re not even part of the labor force anymore! Not because you magically found a job, of course, but because you’re not being counted as unemployed anymore.

The government has improved unemployment. You’re welcome.

Likewise if you have a disability that prevents you from working: You’re not being counted as unemployed either.

Now, who counts as employed? Basically anyone who gets out of bed in the morning: are you working part-time? You’re employed! Helping out your dad for free in the family business? If you’re doing it more than 14 hours a week you count as employed.

Problems masked by the official unemployment rate

Here are problems that the official US unemployment rate masks:

  • Employees lose hours and instead of working full-time they now work only part-time. The unemployment rate doesn’t move!
  • Job seekers get long covid and can’t work? Unmployment rate improves—they don’t count as unemployed!
  • The economy is so bad that big parts of the population give up on finding work? The unemployment rate goes down.

As convenient as that is for politicians, it’s a bit of a problem if you want to figure out the risk of a recession in the next few months. The official unemployment rate, at least without more context, doesn’t help you much.

If you’re interested in a broader way to look at the employment situation, have a look at U-6. Some people call it the “real” unemployment rate.

Where to find the data?