Here's What Janet Yellen Has Wrong About the Job Market

(Bloomberg) -- Janet Yellen might want to take another look at what's happening to the labor market. 

Speaking after Wednesday's Federal Reserve decision to keep interest rates on hold, the Fed chair said steady job growth is attracting people back from the sidelines of the labor force, causing unemployment and other measures of labor utilization to stabilize. She said that's "good to see," and noted that the labor market participation rate – which measures the share of the population working or looking for work – has stabilized and even crept up. "The fact it's increased shows a substantial number of people are being attracted into the labor market,'' she said.

Labor flows data suggest that something else is going on here.

Just to lay some groundwork: there are two scenarios in which unemployment and participation would hold steady. First, people who aren't looking for jobs – those considered "out of the labor force" – might start seeking work. They would be newly classified as unemployed and in the workforce, pushing up both the jobless rate and the participation rate. Yellen favors this story. 

In the alternate scenario, people might be staying unemployed longer, rather than giving up and dropping out of the labor market. That would cause joblessness to stabilize. In this case, as people from outside the labor market find work – think recent college graduates – they aren't offset by labor force exits, and so the participation rate rises. 

The data point to door no. 2. 

As you can see in the graphic above, it doesn't look like unemployment is stabilizing because people are rejoining the ranks of the job-seekers. More people are finding work from out of the labor force, but a smaller number are going from outside of the workforce to unemployment. 

"The entries, combined, have actually been on a steady decline since about March,'' said Omair Sharif, senior U.S. economist at Societe Generale in New York. You can see that in the data below – which just adds together the flows into unemployment and the flows into employment pictured above, and then looks at the change as a share of the overall population. 

The stabilization in unemployment and participation might have something to do with outflows, Sharif said. The number of people who are just giving up on the job search has come down substantially. 

"That's where the upward pressure is coming from on the labor force: exits, not entries,'' Sharif said. "The increase in the labor force, and the corresponding increase in the participation rate, is coming from lower exits.''

That could still be good news for Yellen and her colleagues, even if it's got a slightly different nuance than the situation she described.

The fact that fewer people are just giving up on looking for work might suggest that jobless Americans are either finding jobs or sticking around because they have reason to hope or they're seeing wage gains. And at the end of the day, the outcome is the same: a higher labor force participation rate than would exist if those unemployed people were still leaving the job market.

"They're both good news – they'll take what they can get," said Gennadiy Goldberg, an interest-rate strategist at TD Securities LLC in New York. "The factors that stop people from dropping out are the same factors that draw them back into the labor market."

To contact the author of this story: Jeanna Smialek in Washington at jsmialek1@bloomberg.net.

To contact the editor responsible for this story: Craig Torres at ctorres3@bloomberg.net, Alister Bull