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Surprising Jobless Rate Decline Runs Into Fed Rate Policy

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Jan. 10 (Bloomberg) — The surprising drop in unemployment to the lowest level in more than five years gives Federal Reserve Chairman Ben S. Bernanke little to cheer about.

Employers in December expanded payrolls at the slowest pace in three years, and workers leaving the labor force accounted for much of the plunge in the jobless rate to 6.7% from 7%.

The data highlight a flaw in policy makers’ strategy of setting 6.5% unemployment as a threshold for considering whether to raise interest rates, said Stephen Stanley, the chief economist at Pierpont Securities in Stamford, Conn.

“Even they would admit in retrospect that was not the right thing to do,” said, Stanley, a former economist at the Richmond Fed. “The unemployment rate has gone down much faster than anyone imagined, but it’s been almost exclusively because of shrinking labor-force participation, which is not a good thing.”

The Fed tied its target interest rate to economic indicators in December 2012 with a statement that the rate would remain near zero at least as long as unemployment exceeded 6.5% and the outlook for inflation didn’t rise beyond 2.5%.

At their Dec. 17-18 meeting, Fed officials considered lowering the unemployment threshold to 6%, according to minutes of the gathering released this week. Instead, the Federal Open Market Committee decided to emphasize that rates would remain low even after the jobless rate declined to 6.5%.

‘Well Past’

In its post-meeting statement, the committee said it “likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5%.”

Policy makers “generally” saw “the benefit of avoiding tying the committee’s decision too closely to the unemployment rate alone,” the minutes said.

Officials “will continue to further distance themselves from the whole thresholds framework,” Stanley said.

December’s 6.7% jobless rate is the lowest since October 2008. Economists in a Bloomberg Survey before today’s report forecast the rate would stay at 7%.

The decline came as workers quit the labor force, falling off the rolls of people who are counted as either employed or unemployed. The share of Americans in the labor force declined to 62.8%, matching the lowest level since March 1978.

When policy makers first set the 6.5% threshold, they forecast the rate wouldn’t hit that level until mid-2015.

Collective Judgment

“They’d debated this and come to the collective judgment that the unemployment rate is the single best measure of the labor market,” said Julia Coronado, chief economist for North America at BNP Paribas in New York and a former Fed economist. “The data seem to suggest otherwise.”

Other points of data in the jobs report weakened, underscoring how falling unemployment doesn’t necessarily signal labor-market strength. The average work week fell six minutes to 34.4 hours. Average hourly earnings rose 1.8% in the past year, below economists’ estimates for growth of 1.9%.

“I don’t want to call it a mistake, but it was based on a historical relationship between the unemployment rate and the economy that no longer holds,” Coronado said. “It probably would be helpful if they added, rather than one simple threshold, a more complete description of the indicators they’re looking at.”

Cold Weather

Unusually cold weather may have distorted the payroll report. The figures based on the government’s survey of households showed 273,000 Americans weren’t at work because of weather during the survey week, which last month included Dec. 5, the most for any December since 1977, the Labor Department said.

Last month was the coldest December since 2009, and snowfall was 21% above normal, according to weather-data provider Planalytics Inc. The second week of December was the coldest for any comparable period in more than 50 years, the firm said.

Such distortions may make Fed officials reluctant to alter their strategy to unwind their purchases of bonds, according to Michael Gapen, a senior U.S. economist at Barclays Plc in New York.

The FOMC in December took the first step in slowing the program, cutting monthly purchases to $75 billion from $85 billion. Bernanke said in a press conference that the Fed would probably reduce the pace of purchases at each meeting this year. Officials plan to gather Jan. 28-29 in Washington.

“You have to have a very good reason to change the taper process in one way or another,” said Gapen, a former Fed economist. “They are likely to conclude a lot of this softness in payroll gains was due to weather.”


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