The Labor Market Composite Index (LMCI) was added by the Federal Reserve to determine the proper level of interest rates.
Sterne Agee Chief Economist Lindsey Piegza explained that the LMCI is rather an unfamiliar aggregate index of labor market conditions. Federal Reserve Chairperson Janet Yellen first mentioned the index during the Jackson Hole symposium in August.
Policy makers uses LMCI to easily assess labor market conditions
Yellen decided to add the LMCI as one of the economic indicators to be monitored by policy makers as they experience difficulty in determining the appropriate level of interest rates in the United States. The Federal Reserve has been monitoring the unemployment rate, labor market flows and labor force participation to be able to make proper decision on monetary policy.
The LMCI was developed by a team of four economists at the Federal Reserve to be able to evaluate the overall labor market condition based on a factor model of 19 economic indicators including:
Piegza emphasized that these variables are known. The methodology for the index was not yet released to the public, but the committee recently showed the LMCI via Bloomberg. “A positive reading indicates improving labor market conditions and a negative reading indicates deteriorating labor conditions. However, it should be noted that the entire history of the LMCI may revise each month,” said Piegza in a report.
Yellen pointed out that it is easy to determine a slowdown in the labor market using the LMCI instead of several individual indicators.
During the Jackson Hole symposium, Yellen said, “One convenient way to summarize the information contained in a large number of indicators is through the use of so-called factor models. Following this methodology, Federal Reserve Board staff developed a labor market conditions index from 19 labor market indicators, including four I just discussed.”
Yellen added, “This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.”
Top five indicators in the LMCI as predictors of interest rates
According to Yellen the top five indicators in the LMCI as predictors of interest rates include the unemployment rate, private payroll employment, the insured unemployment rate, the composite help-wanted index, and the jobs plentiful vs. hard to get survey.
“Historically, the LMCI has been a poor predictor or interest rate changes. Although, individually, the aforementioned five key variables of the LMCI are equally unsuccessful at signaling to future interest rate increases,” according to Sterne Agee.