Here’s an interesting report on unemployment:
The concurrent decline in labor force participation, however, has prompted many assertions that unemployment is falling “for the wrong reasons” — i.e., the unemployment rate is falling because unemployed Americans who can’t find work are becoming discouraged and dropping out of the labor force.
This idea has had profound implications for Fed policy.
Fed officials have sought to de-emphasize the decline in the headline unemployment rate — previously considered a key input to policy decision — suggesting it does not reflect the true health of the labor market. This orientation toward the labor market is being used as a justification inside the Fed for continued extraordinary monetary stimulus.
Yet contrary to this popular narrative, the data suggest that the vast majority of the decline in labor force participation in recent years can be accounted for by the retirement of the “baby boomer” generation of American workers.
Consider the findings of a recent study by Shigeru Fujita, a senior economist at the Federal Reserve Bank of Philadelphia, titled “On the Causes of Declines in the Labor Force Participation Rate.”
Federal Reserve Bank of Philadelphia, BLS
Reasons for leaving the labor force can be broken down into three categories: retirement, disability, and “other.” The “other” category is made up partly of discouraged workers. The chart illustrates that in recent years, retirement has been the primary driver of the decline in labor force participation.
Fujita demonstrates that “discouraged workers” only made up about a quarter of those leaving the labor force between 2007 and 2011, while “t he decline in the participation rate since the first quarter of 2012 is entirely accounted for by increases in nonparticipation due to retirement.”
So far I am 100% on board with this “hawkish” article. But then they begin to lose me:
If this is in fact the case, the current headline 6.7% unemployment rate may indeed reflect the true health of the labor market, the inflation the Fed is trying so hard to stoke may be a lot closer at hand than it expects, and the central bank risks falling behind the curve with regard to policy.
I see little risk of that happening, at least under the Evans Rule. Remember, under the Evans Rule the Fed also looks at inflation.
The counterargument is that a wave of discouraged workers will re-enter the labor force as the job market improves, sending the labor force participation rate — and therefore, the unemployment rate — higher again.
Such developments would perhaps constitute a proper justification for continued zero-interest rate monetary policy, in line with the Fed’s projections, which imply no rate hikes for nearly two more years.
Nope, the real argument is that even under the assumption of this hawkish article we still have several millions of unemployed workers who need to find jobs. There is still an output gap. What’s their counterargument?
“Should we really be concerned about the Fed being ‘behind the curve’ given that a rebound in participation should be forthcoming with a rebound in the economy?” asks Drew Matus, deputy chief U.S. economist at UBS, in a note to clients.
Matus implies that the answer is yes.
“Although we believe that there could be a modest cyclical rise in participation as the economy improves, we believe the likely scale of the increase will not significantly alter the basic equation,” he says.
“Payroll growth averaging 200,000 per month should continue to pull down the unemployment rate under all but the most aggressive labor force expansion estimates.”
All of this suggests that labor market conditions are tighter than the popular narrative about the “accuracy” of the headline unemployment rate would have you believe.
If that is the case, the inflation that has thus far been elusive in this economic recovery may be closer than the consensus expects, especially if the unemployment rate continues to plummet toward the Fed’s estimated range of the unemployment rate in the long run between 5.2% and 6.0%.
The Fed should heed the message being transmitted by the headline unemployment rate if it wants to avoid the need for abrupt policy adjustments as the economy continues to improve.
We should welcome an “abrupt policy adjustment.” It’s much better to get to full employment in one year and then abruptly adjust policy to keep NGDP rising along a 4.5% trend line, than it is to have a gradual recovery that asymptotically approaches full employment over many years. Which has been the actual policy since 2009, in case anyone didn’t notice.
Despite my objections this is a very informative article, and should be read by all my fellow “doves” who believe there is a hidden army of 20 million unemployed just itching to get back to work. There isn’t. But 3 to 5 million excess unemployed for demand-side reasons is still a tragedy. After we re-employ them we need to start working on the supply-side problems that reduce employment in America. Step one—replace the minimum wage with a wage subsidy.
PS. Notice the retirement surge after 2011? Count back 65 years and you get 1946. Hmmm, what began in 1946? For the foreseeable future we’ll have roughly as many workers retiring as entering the labor force. (A bit fewer retiring right now, but a bit more than new entrants retiring in 10 years, ignoring immigration.)