In March of last year, the Federal Reserve introduced a new tracking indicator to assess changes in the labor market. It's called the Labor Market Conditions Index (LMCI), which the Fed defines as a dynamic factor model that extracts primary variation from 19 labor market indicators. In other words, the LMCI tracks changes in the labor market by finding variations from multiple labor indicators. Indicators range from unemployment rates to wages to layoffs to business surveys. The LMCI plays a critical role in helping the Fed with one of its two mandates: ensuring maximum employment. It's one of the factors that the agency will take into account when it considers raising interest rates later this year.

Why LMCI?

The thinking behind the LMCI is to consolidate a number of traditional measures of unemployment to create a cohesive picture of the labor market. While announcing the indicator at the Fed's meeting in Jackson Hole, Wyoming, Fed Chair Janet Yellen said the indicator was a “broader gauge” of labor market as compared to unemployment numbers. For example, the LMCI includes statistics related to underemployment, part-time work and long-term unemployment.

To that extent, the LMCI reflects the complicated nature of today's labor market, which is affected by factors ranging from worker displacement due to technology to recession economics. In turn, this complexity has made it difficult for economists to assess the nature and causes of unemployment.

The LMCI has a negative correlation with unemployment rates: it increases with a decrease in unemployment, and vice versa. Thus, it veered into negative territory at the height of the Great Recession and has been consistently increasing in the ensuing recovery. The Fed has made available a backdated data series related to the new indicator from 1976. Based on this series, the LMCI averaged 0.43 from 1976 until 2015. It reached a peak of 28.50 in September 1983 and a low of -43.60 in May 1980. (See figure below).

Last year, the index began on a weak note due to the harsh winter but picked up its pace during the summer months. And in 2015, the index has mostly stayed in positive territory (with the exception of April), lending credence to speculations that the Fed will soon undertake a hike in interest rates.

Problems With the LMCI

A number of economists have questioned the LMCI's relevance and utility in policy. For example, the LMCI's negative correlation with unemployment has led some economists to doubt its efficacy as a measurement index.

In a post on her blog last year, Carola Binder, an assistant professor of economics at Haverford College, wrote that the index was a nice “statistical exercise” but that she was “disappointed” about the LMCI's “almost perfect” negative correlation with the unemployment rate. “The LMCI doesn't tell you anything that the unemployment rate wouldn't already tell you,” she wrote. "Given the choice, I'd rather just use the unemployment rate since it is simpler, intuitive, and already widely-used.”

According to Binder, there's no need for a single statistic to encapsulate conditions in the labor market because it reduces the complexity of various actual figures, such as the numbers of underemployed or long-term unemployed, in the market. And Tim Duy, a professor at the University of Oregon, wrote that the LMCI should be used with “extreme caution” as the Fed has not explained its “policy relevance.”

The problem, in this case, lies in the fact that the Fed hasn't made publicly available the raw data or calculations used for the LMCI. Once that information is available, economists should have a better understanding of the LMCI's nuances for the Fed. The creators of the index have already cautioned that “a single model is no substitute for judicious consideration of the various indicators.”

The Bottom Line

The Labor Market Conditions Index aims to provide a consolidated and holistic picture of U.S. labor conditions to help the Fed maintain maximum employment in the economy. It's been criticized for essentially being a reverse image of existing unemployment figures, and its value may only become clear as the labor market improves and the Fed takes action on interest rates.

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