Here's Why The Unemployment Rate Could Abruptly Drop To 6.8%

The way the U.S. measures unemployment isn't perfect, and it certainly doesn't offer a comprehensive picture of the U.S. job market.

Issues include the ambiguity of how unemployment is defined, the exclusion of those who have given up on looking for work, and also the responses of those being surveyed who may choose to say they are unemployed even though their personal job prospects vary greatly.

All of these issues could collide after the government's Emergency Unemployment Compensation (EUC) program expires at the end of this year. The EUC allowed unemployed Americans to collect unemployment insurance benefits for 99 weeks instead of the standard 26 weeks.

Economists believe many people will take jobs that they were holding out on.

However, economists expect even more people to just drop out of the labor force, which in turn would cause the unemployment rate to drop.

Deutsche Bank's Joe LaVorgna explains (emphasis added):

Currently, there are 1.32 million individuals collecting benefits through the various extended and emergency programs. This accounts for approximately one-third of the total number of unemployment insurance beneficiaries. If the program is allowed to lapse at the end of the year, it would have implications for both the composition of personal income as well as the level of the unemployment rate. Recall that to be eligible to collect unemployment benefits individuals are supposed to be actively looking for work. This is the same stipulation to be counted among the unemployed in the unemployment rate. (If individuals are not working, but not actively seeking a job, they are technically counted as "not in the labor force"-which in turn reduces the labor force participation rate.) If extended benefits expire, the unemployment rate could abruptly fall based on data the BLS provides on the behavior of the long-term unemployed.

Every month the BLS provides data on the number of unemployed people who eventually drop out of the labor force, ostensibly the group who will be most impacted by the expiration of unemployment insurance. If 23% of the current 1.3 million people receiving unemployment insurance drop out of the labor force, which is what the BLS data imply, the unemployment rate will promptly fall to 6.8% from 7.0% currently, all else being equal. Another 850k individuals who are currently in state unemployment insurance programs would be impacted in Q1 2014. This would be worth another tenth on the unemployment rate. As such, the rate could be 6.7% by the March FOMC meeting-purely due to benefits expiration. This does not even account for the ongoing improvement in the labor market. (Remember, we assume employment is unchanged in these calculations.)...

So, we may see the unemployment rate drop largely on a technicality.

"Of course, it is possible that unemployment benefits are extended. Senate Majority Leader Reid said this would be a priority in the New Year, and House Speaker Boehner has also shown a willingness to address the issue," added LaVorgna. "Perhaps this is a source of compromise early in the New Year as a debt ceiling increase will need to be brokered by February 7, otherwise the Treasury Department will have to again resort to extraordinary measures. We doubt there is much tolerance for another debt ceiling fight so soon after the October standoff and so close to the mid-term elections."

We'll see.