Why Is The Unemployment Rate Important?

Unemployed man sitting on the steps

Accessing any form of financial press, or even the nightly news, could bring you into contact with the latest unemployment figures, often in the context of statements made or upcoming releases from the Federal Reserve. Following the financial crisis in 2008, the Federal Reserve of the United States has remained a major topic in nearly any discussion pertaining to markets or the economy, with headlines most commonly being related to low interest rates and the expansion of their balance sheet (also known as “printing money”).  Established in 1913, the Fed was set up primarily as an institution with the aim of adding some measure of stability to the US and, in turn, the global financial system. Overall, it is charged with two main objectives: the management of inflation and maintaining full employment.


The unemployment rate is of prime importance across many facets of society.

It should come as no surprise that the central bank is charged with overseeing a statistic which is one of the key components of Gross Domestic Product (GDP).  However, the unemployment rate is far more than a number related to the country’s economic growth.  For example, unemployment is highly predictive of an increase in crime and uneasiness in the general populace, and can also lead to long term systemic issues which are difficult to resolve.  Also, once someone is out of work for a long enough period of time, they sometimes reach a point whereby they give up seeking long term gainful employment, becoming what is referred to as a discouraged worker.

The goal of the Federal Reserve regarding unemployment is to achieve and maintain what economists refer to as full employment.  This, however, does not mean that unemployment is at or near 0% and that the entire populace is engaged in the workforce.  For example, a significant number of the population is either too young, too old, or disabled to the point whereby they cannot work.  Many families also maintain the setup whereby one spouse works and the other stays home to focus on the family.  These very large portions of the population are not considered in the employment/unemployment calculation; because they either cannot work or do not need to obtain full time employment.  Some other forms of unemployment are, however, included in the calculation; such as frictional unemployment, voluntary unemployment, or structural unemployment.  For example, large sections of the economy maintain a work force which is seasonal or cyclical, and will not have workers at all times of the year.  There will also be at any given time a significant percentage of workers that are between jobs, whether quitting was their decision or their company’s.  Lastly, there are very often times where the jobs are available, but not enough of the population is able to fill these jobs.  Technological advancement and growth in the business cycle is what drives this structural unemployment, and although it is not an absolutely ideal situation for society to have all these unfilled highly qualified jobs; it certainly is not the worst problem to have. These instances impact the unemployment rate, but as long as they stay within reasonable and sustainable ranges, are not treated as a major threat to the economy; and can be present during times still referred to as periods of full employment.

Full employment simply refers to a state whereby, in simple terms, everyone that reasonably can and should be employed, is. It is the condition in which all available labor in any given country is being utilized in the most efficient way possible.  For example, a country may determine that “full employment” to be at a 5% unemployment rate.  Accordingly, in America if the unemployment rate were to go above 5%, this would be deemed unacceptable, and the Federal Reserve would be more likely to consider taking some action to try and steer the country back to within the acceptable ranges.

The two primary types of economic issues that would typically cause a country to experience a spike in unemployment would either be cyclical unemployment or demand deficient unemployment.  Cyclical unemployment stems from the ups and downs of the typical business cycle.  These periodic fluctuations in the normal course of the business cycle drive growth economies and recessions.  Demand deficient unemployment is similar, but is specifically connected to the aggregate demand, which can move independent from the normal business cycle.  When there is insufficient aggregate demand, business will slump, and workers will be laid off at an above average rate.  To take an overly simple example, take a basic economy of a small imaginary island nation which only produces and exports one kind of fruit.  Let us assume in that year, scientists discover that this particular fruit causes excessive weight gain instead of weight loss.  Needless to say, the rest of the world will be suddenly buying a lot less of this fruit, and the demand for this country’s chief export will drop; causing an abnormal level of unemployment completely separate to the normal business cycle.  Fruit producers, canners, shippers, advertisers, etc. will all be losing their jobs. Full employment would not be possible in this situation.

Sources and Further Reading

- Price Flexibility and Full Employment - Don Patinkin, The American Economic Review, Vol. 38, No. 4

- The dynamics of full employment: Social integration through transitional labour markets - G Schmid, B Gazier - 2002

- Frictional Unemployment and the Role of Industrial Diversity - Curtis J. Simon, Quarterly Journal of Economics, Vol. 103, Issue 4