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 July, the unemployment rate increased to 6.2 percent, as expected by last month’s forecast. Going forward, the model now anticipates unemployment to decline slowly over the next 6 months with an unemployment rate at 5.9 percent by the end the year, compared to only 6.1 percent as anticipated by last month’s forecast. The revision to the forecast owes to good news on the unemployment insurance (UI) claims front, which dropped noticeably last month, and to the continued (albeit slow) improvement on the job openings front.
This model’s forecast can be easily understood by looking at the projected behavior of the “steady-state” unemployment rate (SSUR). 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 6.0 percent, 0.2 percent lower than the actual unemployment rate. Our research shows that the actual unemployment rate converges toward this steady state. With a SSUR slightly below the actual rate, the “steady-state convergence dynamic” would tend to push the unemployment rate down going forward. Further, this effect is amplified by an anticipated decline in the SSUR over the coming months with a steady-state rate of 5.6 percent by the end of the year (figure 2). Combining these two effects, the unemployment rate should decline to 5.9 percent by the end of the year.
To forecast the behavior of steady-state unemployment, the model propagates forward its best estimate for how the flows in and out of unemployment will evolve over time. The two most important flows –workers’ job finding rate (UE) and workers job separation rate (EU)— are now expected to improve substantially over the next 6 months, because of a noticeable decline in UI claims (capturing new layoffs) last month and the continuing (albeit slow) increase in job openings. As a result, the SSUR is now expected to decline over the next two quarters.
To read more about the underlying model and the evidence that it outperforms other unemployment rate forecasts, see Barnichon and Nekarda (2012).