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 December, the unemployment rate unexpectedly dropped to 6.7%, whereas the model anticipated unemployment to remain steady at 7%. With this large drop, unemployment closed the gap with its steady-state value in only one month, implying that there is now little room for further unemployment decline in the next few months. I expect unemployment to remain roughly steady over the next six months with an unemployment rate at 6.6% by June 2014.
This model’s forecast can be 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 2— stands currently at 6.7%, just like the unemployment rate. Our research shows that the actual unemployment rate converges toward this steady state. With a steady-state unemployment rate at the same level as the actual rate, the “steady-state convergence dynamic” that pushed the unemployment rate down steadily during the second half of 2013 is now gone. In other words, the downward momentum in unemployment we observed lately should come to a halt in January. Moreover, the model anticipates the steady-state unemployment rate (SSUR) to decline only very slowly over the coming months (figure 2). With such a slow decline in steady-state unemployment, the gap between the unemployment rate and SSUR will remain negligible and no strong downward momentum will develop. As a result, unemployment will remain roughly steady (in fact, declining very slowly) over the next 6 months.
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 in and out of unemployment will evolve over time. With the recent increase in unemployment insurance (UI) claims (capturing new layoffs), the model anticipates a slight increase in the flows into unemployment that prevents the steady-state unemployment to decline strongly despite (slow) expected gains on the job front (following recent increases in job postings, the model anticipates a continuous increasing of the unemployment outflow rate, or job finding rate).
To read more about the underlying model and the evidence that it outperforms other unemployment rate forecasts, see Barnichon and Nekarda (2012).