When the Bureau of Labor Statistics (BLS) announces the unemployment rate every month, financial markets respond instantaneously to the news, the chairman of the Federal Reserve comments on the state of the economy based on the announcement, and many citizens reflect on the stability of their own employment situation. However, the unemployment rate has many limitations as an economic indicator.
The calculation of the unemployment rate dismisses the number of discouraged workers. The BLS classifies discouraged workers as people who are without jobs and who have stopped looking for employment. Discouraged workers stop looking for employment due to a lack of skills, their unsuccessful previous job searches and a lack of available jobs in their field. Therefore, an automotive industry worker in Michigan whose plant was closed and can no longer find work is not factored into the unemployment rate. When the economy is in a deep recession, the number of discouraged workers excluded from the unemployment rate is higher than in times of economic prosperity: The unemployment rate is typically higher than what is revealed by the BLS during economic recessions or depressions.
The BLS removes unemployed people from its calculation after four months. Therefore, if people are unemployed for a long period of time, they are expunged from the unemployment rate. This, too, makes the unemployment rate appear lower than it actually is.
The unemployment rate does not indicate whether workers are in positions that match their unique set of skills. For example, a classically trained musician working at a retail bookstore is not considered unemployed. Likewise, a person with a master’s degree in teaching who is working part-time as a substitute teacher is not considered unemployed, despite his desire to gain full-time employment. Michael Melvin, author of the book, “Economics,” cites underemployment as an example of "hidden" unemployment. Furthermore, Melvin states that a high underemployed workforce means the economy is not living up to its potential gross domestic product (GDP) output.
The unemployment rate does not reflect why the number of unemployed people is higher or lower than in the previous month. For example, if a company decides to outsource its customer service division overseas and 4,000 workers in the Unites States lose their jobs, the unemployment rate does not capture the rising trend of globalization. Additionally, the unemployment rate cannot indicate whether the economy will be able to absorb these customer service workers and provide other jobs. Evelina Tainer explains in her book, “Using Economic Indicators to Improve Investment Analysis,” that the unemployment rate is a lagging indicator, which means that it is slower to provide a full economic picture than other indicators: While other indicators might show a robust economy, a higher unemployment rate could show an economy that is worse than it actually is. Tainer explains that the Federal Reserve does not change the interest rate when economic indicators are announced for this reason.