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Why The Unemployment Rate Fell

Total Unemployed

The government's view of unemployment. Source: Commerce Department hide caption

toggle caption Source: Commerce Department

Economists were surprised by today's drop in the unemployment rate, which went from 9.5 percent in June to 9.4 percent in July. Close watchers of the labor market had expected to see the figure rise to 9.6 or 9.7. White House press secretary Robert Gibbs told reporters today that President Obama still expects to see unemployment hit 10 percent this year.

So why did the number go down in July? Part of the reason is that employers cut fewer jobs — by 247,000, against an average of 331,000 for the last three months, including July.

Another, and perhaps larger part of the answer is that one key number factored into the rate fell unexpectedly. Unemployment is the number of people out of work as a percentage of the total labor force. The labor force in everyone who's employed or who wants a job. In July, that total labor force fell by 422,000.

Sudeep Reddy at the Wall Street Journal's Real Time Economics blog says that the jobless number is down because the overall labor force is shrinking — people are giving up on looking for jobs, and so BLS doesn't count them as unemployed. Reddy also says that when the economy recovers, more people will likely re-enter the labor force and help push the unemployment rate higher. Or as he explains it:

The payroll figures — jobs lost — comes from a Labor Department survey of employers. The unemployment rate is measured through a separate survey of households — asking people whether they have a job, whether they want a job and whether they searched for a job (among other things). If people drop out of the labor force, the unemployment rate can decline because fewer people would be considered jobless.

White House economic advisor Christina Romer told Bloomberg TV that the drop in the labor force did have an effect but wasn't the only factor. "It is certainly arithmetically why the number went down," she said on Bloomberg television. "Basically, what we're seeing is stability."

High Frequency Economics' Ian Shepherdson sees the drop in total labor force as a correction from temporary spikes in April and May. "Assuming more normal trends over the next few months, the unemployment rate has further to rise," he writes.

White House press secretary Robert Gibbs said the $787 billion stimulus had made for a stronger report than expected. "There's no doubt that the economic recovery plan is having an impact," he told reporters.

Everyone's favorite doomsayer, Nouriel Roubini of RGE Monitor, agrees that the unemployment rate fell largely because of people leaving the labor force. He writes that later this year, the job market (and the overall economy) is going to get worse — a lot worse:

All elements of total labor income — jobs, hours and average hourly wages — are under pressure which will impact consumption in the coming months. The unemployment rate in late 2009 will be higher than what was assumed for 2010 in the "adverse scenario" of the banks stress test. This will lead to further delinquencies on loans and securities and lower than expected recovery rates. As people who have mortgages lose their jobs, they will have severe difficulties in servicing their mortgages.

Calculated Risk takes an extended look at those stress tests the U.S. Treasury administered to the nation's largest banks. The upshot: "Once again, the unemployment rate is already higher than the 'more adverse' scenario."

Other Charts: Duration of Unemployment/ Average Hourly Wages/ Average Workweek

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