Recently, there has been some wringing of hands and puzzlement in policy circles regarding the fact that while the unemployment rate is down, wages and consumer spending don’t seem to be increasing and contributing to economic growth the way certain pundits and policy wonks think that they should. The economic policy world has faced these conundrums before. In the 1970’s, economic theory, using the Philips Curve, said that low unemployment leads to high inflation and vice-versa. Pundits then were shocked to see a situation with high unemployment AND high inflation; something that came to be known as stagflation (caused by OPEC raising oil prices). In the late 1990’s, we had the reverse which was low unemployment, rising wages, and low inflation. Again, this was puzzling (the theory regarding the cause of this happy confluence of factors was improved productivity due to the computer revolution), but nobody was really complaining.

Today, we have a situation where the economy is not behaving in ways that theory and experience says that it should. We had a deep recession that statistically ended in 2009, and yet the recovery has been sluggish (unlike prior recoveries). And now, with unemployment finally down, wages (and inflation) aren’t increasing like we expect. What is going on??

While nobody knows the entire answer, one explanation is likely that the statistics (the popular unemployment statistic in this case) simply aren’t honest. Or rather, they don’t capture the economic reality that they once did. In earlier times, an unemployment rate of 5.4% would have meant that the economy was forging ahead and workers could expect raises as the supply of labor was becoming scarce. This is not what is currently happening, creating confusion. The problem is that the statistic simply doesn’t capture the fact that more people than normal have dropped out of the labor force. In earlier time periods, someone dropping out (or not being counted) in the labor force likely meant that either a.) they were never part of the labor force (think “stay-at-home” moms), b.) became permanently disabled or c.) retired. In other words, they could have 500 open jobs sitting in front of them and still would not take a job because they couldn’t (disabled) or didn’t want one.

Today, however, people are dropping out of the labor force because they are discouraged. This is not the same thing as the a.), b.) or c.) options in the prior paragraph. They want work, presumably they have some skills that would give them work, but they can’t find work and give up. These people are as unemployed as the people who are actively looking for work. That the government has decided not to count them as unemployed doesn’t change that fact any more than if the government were to decree that George Washington never existed.

With a real unemployment rate significantly higher than 5.4%, pundits wouldn’t be wondering why wages aren’t increasing, why consumer spending is sluggish, etc. etc.In order to make the best policy decisions, policymakers have to have relevant and accurate information. If the unemployment statistic is no longer relevant given the economic structure of today, then it needs to be changed. Otherwise, pundits and policymakers will continue to be confused when they economy doesn’t respond in ways that they expect. To paraphrase Fezzik in The Princess Bride, pundits should stop using the unemployment statistic as currently constructed; I don’t think it means what they think it means. The sooner everyone accepts this reality, the better.