What is the Unemployment Rate?

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Definition:

The unemployment rate is the percentage of people who aren’t working out of all the people in the workforce.

🤔 Understanding the unemployment rate

The unemployment rate helps you understand how difficult it is to find work at any given point in time. Technically, it is the number of people actively seeking employment while out of work divided by the number of people in the civilian labor force. The result is a macroeconomic indicator of an economy’s health. Importantly, the unemployment rate is not the percentage of a population that is out of work. It does not include people who are not allowed to work (children), unable to work (injured, incarcerated, etc.), or unwilling to work (retirees, stay at home parents, etc.) as part of the labor market.

Example

In February 2020, the seasonally adjusted U.S. unemployment rate stood at 3.5 percent.

Just over 164.5 million Americans were considered part of the civilian labor force. Of those, 158.8 million had jobs, and 5.8 million were out of work.

Dividing the unemployed count by the labor force tells you the percentage of people who wanted work but were unable to find it (5.8 million divided by 164.5 million equals 3.5 percent.)

Takeaway

The unemployment rate is like the speedometer in your car…

When you look at the dashboard as you’re driving, you’ll see a lot of information presented to you about what’s going on. There’s probably an RPM indicator telling you how hard you are pushing the engine. Next to that, you might find a gauge showing you how full your gas tank is. Elsewhere, you likely have warning lights that inform you if something is wrong. Somewhere in the middle, you should see an indication of how fast you’re going. That speedometer lets you know if your current speed (unemployment rate) is consistent with how quickly you want to travel (target unemployment rate).

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How is the unemployment rate calculated?

To calculate the unemployment rate, you need two pieces of information. First, you need to know how large the labor force is. Second, you need to know how many people in the labor force are unemployed.

Determining the size of the labor force is easiest to understand by subtracting out the people who aren’t in it.

You start with the total population. Then, you must subtract the children, seeing as they are not allowed to work. Next, you have to take away everyone unable to work — Perhaps because they are disabled, hospitalized, or incarcerated. Now, you have to account for the people who don’t want to work. This group includes people in college (who aren’t also working), retirees, stay-at-home parents, and anyone else that is not working but is not looking for work. You also have to subtract anyone that is in the military, as the unemployment rate only counts the civilian labor force.

What you have left is the labor force. To get the unemployment rate, you just need to divide the number of unemployed people by the size of the labor force. The result is the percentage of people participating in the job market who don’t have a job.

Unemployment rate = Number of unemployed / Civilian labor force

Take this simplified example:

Population100,000
People under 16 years old10,000
Institutionalized population2,500
Retirees13,000
Other non-participants22,000
Military members2,500
Labor force50,000

In this economy, the population of 100,000 people has a labor force of just half that size. Now, assume that 2,500 people in that population are unemployed. In this scenario, the unemployment rate is 5%.

Unemployment rate = 2,500 / 50,000 = .05

Notice that only 2.5% of the total population is considered unemployed (2,500/100,000), and that 50% of the total population is jobless (47,500 people in the labor force have jobs, plus 2,500 military members are working).

But neither of those numbers is the unemployment rate. Rather, the unemployment rate is a reflection of how difficult it is for a person who wants a job to find one.

Who determines the unemployment rate?

In the United States, the Bureau of Labor Statistics (BLS), a division of the Department of Labor, is in charge of determining the unemployment rate. They complete this task every month by taking household surveys and plugging the data into sophisticated statistical software.

The monthly questionnaire is called the current population survey (CPS), which provides more information about the characteristics of the labor force than simply looking at how many people are receiving unemployment benefits. The CPS includes 60,000 households from across the country. That number of participants in the sample should provide a pretty good idea of how things are going.

While a full count of every person in the country would give an exact answer, that process would be too time-consuming and expensive to complete. The phone survey with a reasonably large sample balances the need for accuracy, efficiency, and speed.

A participant in the survey stays in the sample for four months, with 15,000 new participants replacing those that are removed each month. This process allows some consistency in the reported figures while ensuring that the pool is not static.

Interviewers ask a set of scripted questions, which they input into a computer program. The answers to those questions run through a rubric (scoring guide) which classifies the participant as employed, unemployed, or not in the labor force. From this information, the analysts can determine the labor force participation rate and the current employment situation.

The BLS also identifies five alternative measures of labor utilization with the data collected by the CPS.

These alternative employment statistics help officials understand differences in how long unemployment has lasted, why people are not in the labor force, and the number of part-time workers who would prefer to have a full-time job. Some of this information can expose underutilization of labor and underemployment within the workforce.

What causes the unemployment rate to change?

The most direct and expected way the unemployment rate changes happens whenever a person loses or gains a job. When an unemployed person becomes employed, the rate goes down. Whenever a person loses a job, and starts looking for a new one, the rate goes up.

There are four primary reasons for unemployment to change:

  1. Frictional unemployment happens whenever a person decides to leave their current job to try something new.
  2. Structural unemployment occurs when the job market shifts from underneath a worker’s feet. As the economy changes and renders their job obsolete, they end up unemployed.
  3. Cyclical unemployment arises out of changes to the business cycle (the periodic rise and fall of the economy). When the economy enters a recession (a downturn in economic activity), people often get layoff notices.
  4. Seasonal unemployment happens as the normal process of an industry. Like construction workers getting laid off in the winter.

However, the unemployment rate is the ratio of two numbers. Any alteration to either value will result in a change in the unemployment rate. And that fact makes changes to the unemployment rate a little more complicated than it first appears.

For example, when a teenager turns 16 and puts in an application at the fast-food restaurant up the street, the unemployment rate goes up without anyone losing a job. When a person retires, they leave the labor force without becoming unemployed. Yet, as long as there is at least one unemployed person, the unemployment rate goes up.

When an unemployed person decides to go to college rather than find a new career, the unemployment rate goes down without any employment growth. The same thing happens when someone becomes so frustrated with their inability to find work that they stop looking.

When this happens, the discouraged worker leaves the labor force. As a result, the unemployment rate goes down, even though job prospects did not improve.

How does the unemployment rate affect you?

The unemployment rate is a measure of the strength of the economy. But it is a lagging economic indicator, not a predictive one.

In other words, the unemployment rate tells our elected officials, and us individually, how hard it is to find work. Perhaps that may influence your decision to find a new job. But the statistic doesn’t tell you which direction things are heading next.

If you lose your job, you will become part of the statistic that tells everyone that the job market is getting tougher. So, the unemployment rate describes your situation, but doesn’t affect you directly. You don’t lose your job because the unemployment rate goes up. It’s the other way around.

And as a measure of the whole economy, the same is true. The unemployment rate doesn’t affect the economy — It describes it. Government leaders can use that information to help people when it is needed.

For example, the federal reserve may lower interest rates (called monetary policy), or Congress may increase government spending (called fiscal policy) to create more jobs.

How has the unemployment rate changed over time?

The U.S. Bureau of Labor Statistics (BLS) has unemployment data going back to 1948.

In the 72 years of unemployment rate information, the record low rate was 2.5 percent in May and June of 1953. The highest level of unemployment on record occurred in the winter of 1983, reaching 10.8 percent.

The unemployment rate tends to correlate with the business cycle, as cyclical unemployment increases during a recession. Therefore, a pattern of ups and downs in the U.S. economy is evident in the historical data. During the Great Recession, the unemployment rate in the United States topped out at 10% in October of 2009.

Since the recession ended, the unemployment rate has been on a continuous downward trend. By February of 2020, the U.S. was experiencing a 50 year low unemployment rate of just 3.5 percent. That changed in March of 2020, as the novel coronavirus and related nationwide shutdown of businesses caused a record spike in unemployment claims.

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