Labor Market Conditions Index: What It is, How It Works

The Labor Market Conditions Index (LMCI) was a measurement tool produced by the Federal Reserve to gauge the momentum of the labor market in the United States. The tool relied on 19 indicators—such as the unemployment rate, payrolls, hourly wages, job vacancies and confidence surveys—to produce a single number that was meant to reflect the overall direction of the labor economy.

The index once played a role in helping the Fed pursue its mandate of maximum sustainable employment. However, economists saw little value in the index, noting it largely provided the same information as the unemployment rate. The Federal Reserve introduced the LMCI in March 2014 and stopped updating the index in August 2017. 

Below we look at the history of the LMCI.

Why LMCI? 

The thinking behind the LMCI was to consolidate 19 measures of labor market activity into a single, cohesive picture. Janet Yellen, then chair of the Federal Reserve, said its purpose was to better reflect the complicated nature of the labor market than what traditional unemployment numbers could provide. For example, she noted that while wages appeared to be rising by 2 percent annually, in real terms wages had been flat and growing less than labor productivity.

In essence, the LMCI was meant to smooth out conflicting signals in labor market activity. The unemployment rate might be say one thing about labor conditions, while high job vacancies might say another. The index was meant to weigh these conflicting signals and produce a single number to describe overall labor conditions.

Fed researchers back-tested the index by 35 years. The index generally fell during economic contractions, and rose as the economy recovered. For example, during the Great Recession, the back-tested data showed the index falling beginning in the second quarter of 2007 and deteriorating sharply in 2008 and 2009. The LMCI then improved from 2010 onward.

Problems With the LMCI 

A number of economists questioned the LMCI's utility. Carola Binder, assistant economics professor at Haverford College, noted the LMCI had a -0.96 correlation coefficient with the unemployment rate. In other words, as unemployment rose, the LMCI fell by nearly the same amount. 

"The LMCI doesn't tell you anything that the unemployment rate wouldn't already tell you," Binder wrote. "Given the choice, I'd rather just use the unemployment rate since it is simpler, intuitive and already widely used." 

Binder said there was no need for a single statistic to encapsulate conditions in the labor market, because this reduced the complexity of various actual figures—such as the numbers of underemployed or long-term unemployed—in the market.

Tim Duy, economics professor at the University of Oregon, wrote the LMCI should be approached with "extreme caution" because the Fed had not explained its policy relevance. Duy said it was difficult to treat the LMCI as important because the Fed hadn't made available the raw data in its calculations. 

In addition, Fed researchers had cautioned that "a single model is...no substitute for judicious consideration of the various indicators."

The End of LMCI Updates

The Federal Reserve announced on August 3, 2017, that it would discontinue updating the LMCI. The Fed said it believed the index no longer provided a good summary of changes in U.S. labor market conditions. It noted the measurement of some indicators had changed in the years since the index was introduced. In addition, it said including hourly wages in the index did not provide a meaningful link between labor market conditions and wage growth.