A Dark Side to the Drop in the Jobless Rate (BusinessWeek)

An employee loads a box with merchandise at Amazon's fulfillment center in Tracy, Calif.

The drop in the U.S. jobless rate to 5.6 percent, the lowest since June 2008, is good news and bad news. It’s good, of course, in that fewer people who are in the labor market can’t find jobs. It’s bad because it’s a sign that the economy is getting closer to its speed limit—the fastest it can go without overheating like a car with a boiling-over radiator.

This chart shows the surge in the jobless rate and subsequent fall over the past decade.

When the unemployment rate gets into this range, it’s harder for employers to find qualified workers so they start bidding up wages. Some of that is good, a much-needed catch-up from years of declines in labor’s share of the national income. But the inflation fighters at the Federal Reserve worry that tight labor markets could set off an inflationary spiral.

We’re a long way from that right now. Average hourly earnings actually fell 0.2 percent in December, the first monthly drop since 2012. But members of the rate-setting Federal Open Market Committee are keeping a close eye on the jobless rate in deciding when to raise the key short-term lending rate they control, the federal funds rate, which has been stuck on the floor of zero to 0.25 percent since the end of 2008. A rise in rates would tend to slow down economic growth.

Members of the FOMC have different estimates of the long-run stable level for the unemployment rate, ranging from 5.0 percent to 5.8 percent. In other words, the current jobless rate is well within the range of what FOMC members believe to be the sustainable rate—the one that is as low as it can go without setting off rising inflation.

One reason that the jobless rate is this low is that during the long slump, many people simply dropped out of the labor force. Here’s a chart of the employment-to-population ratio—i.e., the number of employed people as a share of the adult population.

If more people went back to work, it would ease the pressure in the labor market, allowing the expansion to continue longer. But it’s not happening much. Part of the drop is the aging of the baby boom; another part is an increase in disability. Many people who dropped out may never come back. That’s the dark side of the drop in the unemployment rate.