The rate of unemployment refers to the number of unemployed as a percentage of the total labor force. The Bureau of Labor Statistics counts people as unemployed if they do not have a job and have been actively seeking work in the previous four weeks.
Rising unemployment is a telltale sign of recession and is one of the core factors that the NBER uses to determine business cycle start and end dates. There is a close relationship between output and unemployment. As people lose their jobs, consumer spending declines, resulting in lower demand and output. Conversely, companies lay more people off when they have fewer things to produce.
This relationship between output and unemployment is capture by Okun’s law. Named after economist Arthur Melvin Okun, it says that a one percent increase in unemployment is associated with a two percent decrease in GDP growth relative to its long-run trend.
As is illustrated in the chart above, unemployment tends to shoot up quickly when a recession starts but then falls at a much slower rate. In this way, a peak in the unemployment rate following a spike signals that the recession is likely over.
A related indicator is the Sahm rule, which uses the unemployment rate to predict the start of a recession. The Sahm rule says that a recession starts when unemployment rises .5 percent or more relative to its 12-month low.
The unemployment rate can sometimes underestimate the number of unemployed because it does not take into account marginally attached or discouraged workers. Marginally attached workers are people who want a job but are not actively looking for work. Discouraged workers form a subset of the marginally attached. These are people who want a job but do not believe they can find one for a number of reasons including their perception that a job is not available, a lack of training or discrimination. However [the trend in unemployment tends to look very similar when we take marginally attached and undermployed people into account.