Unemployment projected to drop to 5.4% in June and reach 4.7% by December

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 May, the unemployment rate ticked up by 10 basis points to reach 5.5 percent, while the model was anticipating a 20 basis points decline. This is the second consecutive large miss for the model, which has been very optimistic in the recent months, anticipating large unemployment declines that did not materialize. The miss this past month was due to (i) a slightly lower than expected gains in worker’s job finding rate (U to E, figure 4), and most importantly, (ii) a very large decline in the rate at which workers leave the labor force (U to N, figure 4), which contributed to raise unemployment in May. Since that second factor is expected to be transitory, the model remains optimistic going forward. The model predicts a jobless rate of 5.4 percent for June, declining steadily thereafter to reach 4.7 percent by the end of the year.

The model’s forecast can be easily understood by looking at the projected behavior of 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 5.1%, 0.4 percentage point lower than the actual unemployment rate. Our research shows that the actual unemployment rate converges toward this steady state. With the steady-state unemployment rate lower than the actual rate, this “steady-state convergence dynamic” will push the unemployment rate down strongly, implying a steady decline in unemployment going forward.

To forecast the behavior of steady-state unemployment, the model propagates forward its best estimate of how the flows in and out of unemployment will evolve over time. Following months of good news on the job openings front, the model anticipates strong growth in the job finding rate (U to E) over the next few months (figure 4), which will push down the steady-state unemployment rate, and will lead to a steady decline in the unemployment rate strongly over the next 6 months.

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