Misconceptions About The Unemployment Rate
The unemployment rate is potentially useful as a measure of labor market tightness, which is the degree of difficulty firms face in hiring workers. However, there are two ways in which the unemployment rate might mismeasure labour market tightness. First, some people, referred to as discouraged workers, are not counted in the labor force[*] and have stopped searching for work but actually want to be employed. Thus, during a long recession, when the level of aggregate economic activity is depressed for an extended period of time, it is possible that the unemployment rate might fall only because some unemployed people have become discouraged and stopped looking for work. In this circumstance, labour market tightness would not really have increased with the decreased in the unemployment rate, but we might be fooled into thinking so.
The second factor that could cause the unemployment rate to be a bad measure of labour market tightness is that the unemployment rate does not adjust for how intensively the unemployed are searching for work. Thus, it could be the case that when the unemployment rate is high, the unemployed do not search very hard for work, because they think their chances of success are low. For example, each worker might spend only one or two hours per day trying to look for work. However, when the unemployment rate is low, the unemployed might be searching very hard, because their prospects of success might seem good. For example, each worker might search eight or ten hours per day. If this were the case, we might actually think of a high unemployment rate as being associated with low labor market tightness. For example, if a firm is looking to hire, it is more difficult to find workers if the unemployed are not looking hard for work.
Williamson, S. (2010). Macroeconomics, 3rd Ed. Toronto: Pearson Education Canada, pg. 53.
*Note: To not be in the labor force means to be neither employed nor unemployed. However, to be unemployed means to not have been employed during the past week but actively searched for work at some time during the last four weeks. I have been told by an expert in personal finance that on average it takes a person eight weeks to find a new job after losing their old one; hence for the latter four weeks of being out of a job, they have technically dropped out of the labor force. The amount of time needed to find a job tends to be much higher during a recession, thus one ought to take people’s quotations of the unemployment rate with a grain of salt. For the record, the “jobless rate” is the same thing as the unemployment rate, i.e. subject to the same ambiguity.