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Chart In Focus

Unemployment Rate Rising On Schedule

Chart In Focus
September 04, 2009

The Labor Department made big news on Sep. 4 with the release of its monthly Employment Situation Report. Total nonfarm payrolls declined by another 216,000, which was not far from expectations. The surprise was that the unemployment rate rose from 9.4% to 9.7%.

A lot of energy gets expended in the media talking about the specific numerical level of the unemployment rate, and for good reason. There is definitely a difference in economic terms between 8% and 10% unemployment. The 9.7% published rate might be a surprise to many, but the fact that unemployment is still rising does not come as a surprise to our newsletter subscribers, who have already seen this week's chart. It shows that the CPI inflation rate leads the unemployment rate by about 2 years. It has been working this way for more than 40 years, and pretty much puts to rest the whole idea that the Phillips Curve has any merit.

The Phillips Curve refers to the belief that unemployment and inflation are linked in real time, and that falling unemployment in a strong economy should lead to rising inflation. The real story is that inflation leads unemployment by 2 years. The belief that they operate in an inverse correlation likely arose from the roughly 4-year period of the business cycle. Since the 2-year lag time is half of that business cycle period, it appears that the two operate inversely when in reality they reflect the same cycle but are just out of phase.

When we adjust for that 2-year lag time in the chart, we find that the inflation rate tells us pretty nicely when the turns should come in the unemployment rate. The correlation is not perfect, it is just really really good. The decline in the unemployment rate into its 2007 bottom was a bigger decline than inflation had called for, and can likely be explained by the strength of the housing sector employment during the housing bubble.

Because inflation was rising 2 years ago, we are now feeling the effect of that inflation in the unemployment rate. The collapse of the housing bubble is likewise giving us a bigger rise than the inflation model called for. If the 2-year lag time works perfectly this time, then we are not likely to see the unemployment rate turn down until July 2010, two years after the July 2008 peak in the CPI inflation rate. Past tops have seen early or late arrivals, so don't chisel that precise date into your calendar.

The good news for jobseekers is that in late 2010 and early 2011 we should see a dramatic drop in the unemployment rate. And that drop won't have been brought about by stimulus packages, retraining programs, tax policy, or anything else coming out of Congress. Instead, it will be the echo of the drop in the CPI inflation rate we are seeing right now. There is a great lesson here for policy makers: If you want low unemployment, all you have to do is arrange to have low inflation, and then wait 2 years.

You can learn more about using this time-lag offset charting technique in several of the articles in our Learning Center. We also have a DVD of a seminar on Liquidity Waves at our Books and DVDs page.

Tom McClellan
Editor, The McClellan Market Report

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