Today's Employment Situation report from the Labor Department seems like unambiguously positive news across the board: jobs are up, unemployment is down, earnings are up, and the duration of unemployment spells is down. But it contains a real surprise: the unemployment rate keeps trending down below expectations and now stands at 5.0 percent. While conventional wisdom is stuck in the mindset that the U.S. economy is weak, the data continue to say otherwise. According to the text of the report,

The jobless rate in June was 5.0 percent, seasonally adjusted. It has trended downward since February 2005 and is now 1.3 percentage points lower than its most recent high in June 2003. The number of unemployed persons was little changed over the month at 7.5 million, but is down by 1.7 million since June 2003.

Students of introductory economics are taught that there is a "natural" rate of unemployment above zero, an acknowledgement that there are always some people between jobs. The naïve belief is that a fully performing economy would employ one hundred percent of its willing workers, but experience and economic analysis teach us otherwise. If the average worker is between jobs for just six months per decade, then the average unemployment rate is five percent. If the rate drops below the natural level of employment, labor markets get too tight, and wage inflation takes off as firms bid up scarce labor.

The orthodox view for many decades was that the "natural" rate of unemployment was somewhere between 5.5 and 6.0 percent. The unemployment rate's descent to the 4-percent range in the late 1990s made many economists skittish about saying exactly what the natural rate is. As a result, you won't find many economists speculating about whether the current rate is natural or unnatural, but there is no doubt that a 5.0 percent unemployment rate is better than good and a symbol of real economic strength.

Two Key Points About the Unemployment Rate

• The last time the rate was 5.0 percent was in September 2001.
• The unemployment rate averaged 5.8 percent in the 1990s and 7.3 percent in the 1980s.

Revised Payrolls

Payroll employment rose by 146,000 in June, which is already being characterized as "disappointing" by CNN.com. However, May payroll figures were revised up by 26,000 to 104,000, and April's payrolls were upped by 18,000 to 292,000. Upward revisions have been the norm for a year now, averaging 26,300 since last July. These upbeat revisions never have the impact that the preliminary data do on the media, which may explain why the media and public are so pessimistic.

Perceptions of employment strength depend on the baseline: how many jobs are necessary to keep the economy growing? If the population were perfectly stable, no new jobs would be needed, but America's population is vibrant, requiring new jobs to keep the unemployment rate low. The usual baseline was believed to be around 150,000 jobs per month-any number above that indicated expansion while any number below indicated a probable uptick in unemployment. But new research from the Atlanta Federal Reserve by Julie Hotchkiss shows that "the more appropriate job creation target to keep unemployment under control is 1.17 million jobs per year, or about 98,000 jobs per month."[1] Demographic trends such as an aging workforce and declining teen participation rates mean that the conventional economic forecasts and media barometers for payroll numbers are plain wrong. In other words, expectations are being set too high for payroll growth, and the actual data are better than realized, not worse than expected. 

The real lesson is that once again, payrolls are the wrong measure of labor market health, and the unemployment rate is the right one. 

The lesson for policymakers: don't mistake the strong 2005 economy for a weak one. Spending stimulus by the federal government is never a good way to manage the macro economy, but it is doubly bad when the economy is at full speed. Growth is strong, inflation is tame, employment is hardy-but the demographic retirement shock is coming quickly. This rare season may be the last, best chance to rein in federal spending.

Tim Kane, Ph.D., is the Bradley Research Fellow in Labor Policy in the Center for Data Analysis at The Heritage Foundation.