13% Unemployment Rate Assumption No Test of Bank Health

Posted on March 13, 2012

The “Supervisory Stress Scenario” included in the Board of Governors of the Federal Reserve System Comprehensive Capital Analysis includes an unemployment rate variable that reaches 13%. Prior to the 21st century that would have been a high hurdle. In today’s world, complete with a global labor pool and the return of single income households this scenario could happen easily without causing harm to the banks and thus makes it a far less meaningful variable.

Reaching an unemployment rate of 13 percent using the most recent household employment and working age population levels would require that roughly 8.42 million people now listed as not in the labor force become encouraged enough to resume their job search. This would increase the size of the labor force from its current size of 154.87 million to 163.29 million people. Through February 2012 there were 142.065 million people employed or otherwise engaged in productive activity according the latest household survey. That would leave 21.228 million people unemployed and an unemployment rate of 13 percent.

Source: The Mays Report

It would also raise our labor force participation rate to 67.35%, a level not seen since April 2000 when the US unemployment rate was a paltry 3.84 percent.

It’s almost certain that the stress test designers had a drop in employment in mind when they selected the 13% unemployment rate. However, the structure of the labor force within our still expanding working age population has changed drastically since the turn of the century in ways that have been well documented by the author and others.

At a glance it would seem that the employment to population ratio would be the best way to measure any economic impact of employment. However, since the recession ended in June 2009 the ratio has slumped, falling by an extra percentage point before rebounding recently to a still anemic 58.6 percent.

Of course this example is just one or several ways one could arrive at an unemployment rate of 13 percent. One could also reduce employment to a level that would produce the same unemployment number. The problem with that is when there is a reduction in employment, an unknown percentage of those workers drop out of the labor force. The size of the labor force is the unpredictable wild card in a case of a decline in employment in the same way that the number of people employed are in a case of rising labor force participation.

Its pretty clear that we either need to develop a new way to measure the economic impact of employment on our economy or define and accept a new normal for employment levels and move forward from there. Either way, using the unemployment rate will not tell us anything about the health of US banks.

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