Unemployment Is About as Low as It Gets

(Bloomberg Opinion) -- A record-long bout of hiring has driven the U.S. unemployment rate down to 3.8 percent, the lowest level since April 2000. So how much lower can it go? Judging from the latest jobs data, it might finally be nearing the limit.

Great as it would be if everyone who wanted a job had one, the economy needs a little unemployment. If the demand for workers outstrips supply by too much, it can start an inflationary spiral in which wages and prices drive each other higher. Economists at the Federal Reserve think that in the longer run, the "natural" unemployment rate should be somewhere between 4.2 percent and 4.8 percent.

So how can a rate of 3.8 percent be OK? One reason is that it might not represent the whole pool of available workers. During and after the last recession, millions of people gave up seeking work, and hence weren't officially counted as unemployed. More recently, many of them have reentered the labor force, helping to meet demand and relieve upward pressure on wages. The prime-age labor-force participation rate, for example, went from a low point of 80.6 percent in September 2015 to 81.8 percent in May 2018, an added supply of 2.4 million workers.

The big question, then, is how many more people might come off the sidelines. One way to get a sense: Look at the gross number of people entering the labor force. If it's unusually low as a percentage of the population, then maybe the available reserve is tapped out, leaving only those who are disabled, in early retirement or otherwise unlikely to return to work. If not, then perhaps improved job prospects can still draw some people in.

From March through May, a monthly average of 2.3 percent of the civilian population changed status from "not in the labor force" to either "employed" (meaning they found a job) or "unemployed" (meaning they started actively seeking a job). That's the lowest level since July 2000, and repeats a pattern seen toward the end of the last two economic expansions.

The "churn rate," the sum of flows among all labor statuses, offers a similar picture. In May, the three-month average fell to 6.1 percent of the population, the lowest point on records that go back to 1990.

All this suggests that the supply of workers is as tight or tighter than it has been at any point in the past few decades. It also suggests that the unemployment rate is becoming a more meaningful indicator -- one that is already well below most estimates of the "right" longer-run rate. Perhaps the Fed wants to keep it low and allow for a little more inflation, but the rate probably can’t go much lower without becoming a problem. 

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