Unemployment Rate Projected to Drop to 7.4 percent in May

The unemployment numbers for April were in line with last month’s forecast: Improvements in the labor market are accelerating and hiring is expected to increase at a solid pace over the next 6 months, bringing the unemployment rate down to 6.8% by December 2013.

This post discusses my monthly update of the Barnichon-Nekarda model. For an introduction to the basic concepts used in this post, read my introductory post (Full details are available here.)

In April, the unemployment rate dropped to 7.51% (rounded to 7.5%), very close to the model’s forecast (7.55%, rounded to 7.6%, see Table 1), and the contour of the forecast is unchanged compared to last month: the motel anticipates a solid rebound in the labor market driven by strong improvements on the hiring front: the jobless rate is now projected to reach 6.8 % by December 2013 (Figure 1).

The intuition for this forecast is easily understood by looking at the projected behavior of the “steady-state” unemployment rate. The steady-state unemployment rate, the rate of unemployment implied by the underlying labor force flows—the blue line in figure 5— stands currently at 7%. Our research shows that the actual unemployment rate converges toward this steady state. With a steady-state unemployment rate significantly lower level than the actual rate (7 versus 7.5, a 0.5 percentage point difference), this “steady-state convergence dynamic” is strongly pushing the unemployment rate down, implying a fast decline in unemployment going forward.

Going forward, the model anticipates the decline in steady-state unemployment to continue at a strong and steady pace, with a steady-state unemployment rate at 6.4% in December (Figure 3). The steady-state convergence dynamic will thus continue to push the unemployment rate down at a steady pace until the end of the year.

To forecast the behavior of steady-state unemployment (and hence of the actual unemployment rate), the model propagates forward its best estimate for how the flows between employment, unemployment and out-of-the labor force will evolve over time. With continued improvements on the hiring and job separation fronts over the past months, the model now anticipates a strong increase in workers’ job finding rate over the next several months (UE, figure 3) and thus a fast decline in the steady-state unemployment rate.

To read more about the underlying model and the evidence that it outperforms other unemployment rate forecasts, see Barnichon and Nekarda (2012).