• The unemployment rate that signifies labor market tightness falls as the workforce gets older and becomes better educated. All else equal, a workforce that is growing older and more educated should steadily, over time, reduce the unemployment rate that is consistent with a given wage target. These compositional changes in the workforce have occurred and have reduced unemployment by roughly 0.3 percentage points since 2000, meaning that an unemployment rate of 3.7% today is equivalent in its effect on wage growth to a 4.0% unemployment rate in 2000.
• Today’s measured unemployment rate captures fewer jobless workers than it used to. Growing nonresponse in the survey used to calculate the unemployment rate has reduced the unemployment rate consistent with a given wage target over time by another 0.3 percentage points since 2000. Growing evidence shows that nonresponse to this survey is not random: rather it is jobless workers who are less likely to respond to the survey that is used to calculate unemployment. This biases the measured unemployment rate downward.
• There may be a bigger pool of workers competing for jobs than the unemployment rate suggests. Adults not in the labor force today seem substantially more substitutable with adults officially classified as “unemployed” than was the case in the late 1990s recovery. For example, the share of newly employed workers who enter employment from out of the labor force is substantially higher in recent years than in past periods of low unemployment, and the downward pressure that adults not participating in job searches put on wages is higher now than in the late 1990s. In short, many potential workers today are not being classified as unemployed, and hence may be missed by focusing only on the unemployment rate as a measure of labor slack.

The rest of this brief highlights evidence on these three points.

A lower unemployment rate is needed to signify labor market tightness with an older and better-educated workforce

All else equal, workers with more experience and education credentials have lower rates of unemployment. The economic intuition for this is that more experienced and more educated workers have skills that are in greater demand by employers at any given level of economy-wide slack. This demand premium for more experienced workers holds in the aggregate despite the fact that age discrimination afflicts many workers, i.e., the unemployment/age gradient is clearly downward sloping.

Lower unemployment among more experienced and educated workers means that a given unemployment rate (say 4%) achieved in two different years can signify different things about the labor market if the composition of the workforce has changed. An unemployment rate of 4% might signal a moderate degree of slack for a highly educated and more experienced workforce, but may signal a very tight labor market for a workforce that is younger and with fewer credentials. Figure A shows the actual unemployment rate and the composition-adjusted unemployment rate for two time periods: 1997–2000 and 2016–2019. Both periods saw unemployment below 5%. In the first period, the difference between actual and composition-adjusted unemployment is trivial (essentially by construction—we fix the demographic composition of the workforce at its 1995 level, as described in the note to the figure). By the 2016–2019 period, the composition-adjusted unemployment rate is nearly 0.3 percentage points higher. In essence, after controlling for age and education, the unemployment rate today has to be roughly 0.3 percentage points lower to signify the same level of labor market slack as it did during the late 1990s recovery. We also adjusted unemployment by race, ethnicity, and gender (not shown in the figure), but this changed the composition-adjusted unemployment rates only trivially compared with the effects of age and experience.

To be classified as “unemployed,” adults must be both jobless and actively searching for work. Those who are jobless and not actively searching—even if they would like a job—are classified as “not in the labor force.” For economists assessing the state of labor market slack, it would be more convenient if the line between unemployed and not in the labor force was bright and stable over time. For example, if adults labeling themselves “not in the labor force” were quite adamant that they were not going to work in the near future—either because of responsibilities (like child or elder care) or out of simple preference—then they would be solidly outside the scope of “unemployment.”

In the immediate post–World War II period, this line likely was pretty bright and unchanging for a relatively privileged subset of middle-class two-parent families: Men were expected to always be working or looking for work, while women were not expected to be part of the paid labor force. Over time, however, the line has gotten ever fuzzier. For example, newly employed workers who transition into employment from being out of the labor force in the previous month have always constituted a majority of the newly employed, but their share has reached historic highs in recent years. Between 1997 and 2000, this share averaged 64.4%, but between 2016 and 2019, it averaged 71.3%. Figure C shows the changing share of newly employed workers transitioning from out of the labor force in the last three decades.