U3 or U6: Bob Brusca or Joel Naroff

Author: David R. Kotok, Post Date: October 24, 2017
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We are privileged to invite readers to a serious debate and discussion. Recently we published two pieces in which we tried to describe markets in terms of metaphors. We thank readers for their many thoughtful responses.

In the second “metaphor” piece we incorporated three charts prepared by Bob Brusca, an economist and longtime friend. Another longtime friend who is also an economist, Joel Naroff, replied and disagreed with Bob. The result is reproduced below, unedited by me. We thank both of our friends for outlining their views and for giving us permission to make them public.

Here is the link to the second metaphor piece, in which I used Bob’s work: http://www.cumber.com/markets-metaphors-labor-data/.

Below is Joel’s reply to that commentary, and following that is Bob’s response, in which he disagrees with Joel. We hope readers enjoy the articulation of these different views.

David R. Kotok
Chairman and Chief Investment Officer
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From Joel Naroff:

David:

Thank you for writing this piece and thank Bob for the research. You have provided the platform for me to make my favorite arguments why the participation rate and U-6 are irrelevant.

Let’s start with the participation rate. If you believe that the decline in the rate explains the decline in the U-3 rate, then you have to be consistent when the participation rate rose.

Consider the period January 1977 to January 1981. The participation rate rose 2.3 points. Using the Brusca rule, there should have been roughly a 2.1 percentage point rise in the unemployment rate. But during that time, the unemployment rate fell as much as 2.3 percentage points and ended up, after four years, down 0.3 percentage points.

So, what are the data telling us about the economy between January 1977 and January 1981? First of all, after four years, you can reasonably say that the unemployment rate was down 2.4 percentage points (2.1 points from the rise in the participation rate and 0.3 from the actual fall in the U-3 rate). That is a really outstanding performance. Also, the unemployment rate averaged 6.6%, which is 1.3 percentage points below where it was in January 1977. Given the huge rise in the participation rate, that is an awesome performance.

In other words, using the participation rate, we now know the answer to Ronald Reagan’s famous question: “Are you better off today than four years ago?” The answer is unambiguously yes. Congratulations, you have made Jimmy Carter an economic guru!

And then there is the U-6, which some call the real unemployment rate and I call the really stupid unemployment rate. One of the major components of the U-6 is the number of people who want full-time jobs but cannot get them. To make comparisons over time, you have to assume there has been no structural shift in the usage of part-time vs. full-time workers. But we know that businesses have been moving toward a higher usage of part-timers as they can more effectively employ them at lower costs.

That more people cannot get full-time jobs is related to the production function, which is shifting. It is not a measure of unemployment. Since the shift has been to more part-timers, the U-6 is biased upwards, which explains the different movements in the two. Very simply, you cannot compare two periods where the production function has shifted, changing the relative usage of labor. Now you can complain that businesses are keeping the “real” or “really stupid” rate up by using more part-timers, but that is a wholly different argument that I doubt you, Bob or any of the others that actually believe the U-6 is meaningful want to make.

Which brings us to Fed policy. If the U-6 doesn’t mean anything, then you have to go back to the U-3 and that is signaling a tight labor market. The problem we face is that given the global labor force and technology changing the way labor is employed, we do not have a good handle on what is full employment. Thus, we don’t know how much slack there really is in the market.

I don’t know how many times I have written this diatribe, but hopefully you will reprint some or all of the argument. You have my permission.

—Joel


From Bob Brusca:

David,

I would like to thank you for featuring some of my work on unemployment. And I would like to thank Joel Naroff for his insightful comments. Now I would like to add a few words to this discussion.

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