A Big Miss: 74,000 Jobs Created, Labor Force Shrinks Again

by Patrick Brennan

December wasn’t a great month for the U.S. jobs market: The economy added just 74,000 jobs this past month — 198,000 were expected, and the economy had been creating about 200,000 per month toward the end of the year (and created 182,000 per month over the course of the whole year). While the unemployment rate dropped a full three tenths of a percentage point, to 6.7 percent, this was mostly a drop in the labor-force-participation rate. The share of Americans in the labor force dropped by to 62.8 percent, tied for its lowest reading since 1978.

This is a decidedly bad sign, if it stands up to revisions: While the participation rate is now just what it was in October, October was a screwy month, because of the government shutdown and some other issues with the data. It looked like hundreds of thousands of people had left the labor force that month, but then returned in November, which is not how the government shutdown should have shown up in the data, but it is, meaning the drop was just a temporary concern — but now a similar number of people left the workforce in December. (Another bad sign: Hours worked edged down slightly, to 34.4 hours per worker.)

Why was it so bad? Some Wall Street economists are blaming the weak December performance on the weather — indeed, the number of people who said they had a job but couldn’t work in December was significantly higher than usual (via Danny Vinik of Business Insider). Another point for that theory: Construction employment, which has been a strong point for a couple years now, dropped by 16,000, and not because the real-estate market is cooling off.

One important thing about the gap between payroll growth and the dropping unemployment rate: This creates a challenge and an opportunity for the new Fed chairman, Janet Yellen. On the one hand, the Fed has made certain promises about when it would start tightening its policies (in particular, by raising interest rates finally, from 0) that are mostly predicated on the unemployment rate. For that reason, a jobs report like this will probably not be good for the markets, because it moves the Fed one step closer to ending its relatively loose money policies. In fact, the Fed’s current rule suggests that rates should be raised when unemployment hits 6.5 percent or inflation expectations hit 2.5 percent — consistent with a healthy labor market and steady long-term inflation expectations otherwise. The caveats about the labor market means that Yellen isn’t really 0.2 percentage points away from raising the Fed’s interest rates (for one, she will never do this until QE is over), but she has to clarify what her preferred rule is, and soon.

But on the other hand, the growing realization that a lower unemployment rate may not actually reflect a healthy labor market should also offer Yellen the opportunity to make more formal some ideas Bernanke has hinted at — deemphasizing the official unemployment rate (which he says “probably understates the weakness of the labor market”) as a trigger for monetary policy and moving toward other, more rational rules for the Fed.

Besides the shrinking labor force, one other reason the unemployment rate managed to drop while the jobs added (a number obtained from employers) looked so weak: The jobs number used to calculate the unemployment rate was bigger than 74,000 — the unemployment rate uses the “household” survey, which asks people whether they’re employed rather than asking companies whether they’ve hired anyone. By that number (which can differ in real ways, e.g., if self-employment grows, but is generally considered less reliable), 143,000 jobs were added in December.