Joblessness and the Fed

 | Dec 19, 2012 | 2:30 PM EST
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When the Federal Reserve recently implemented its latest round of bond buying and said that low interest rates would persist at least until the unemployment rate fell below 6.5%, one might have wondered how long that would take. It turns out, it might not be until 2016 before unemployment is reduced below the Fed's target, assuming the economy keeps growing between now and then.

One reason is that the unemployment rate has fallen as more people have dropped out of the labor force, thus they are not counted as unemployed. (The labor force consists of people either working or actively looking for work. One must be actively looking for work to be classified as "unemployed" instead of "not in the labor force.") Reduced labor force participation rates have lowered the unemployment rate, not because large numbers of the unemployed have actually found work.

This trend is unlikely to continue to the same degree as in the recent past, so we might not see continued drops in the unemployment rate from a falling labor-force-participation rate, which is the percentage of the population age 16 and over who are either working or looking for work. Instead, the reverse might happen: People may re-enter the labor force, pushing the unemployment rate up, unless they immediately take a job. As the economy creates jobs or as people complete schooling that they dropped out of the labor force to pursue, or when people simply run out of savings, they may restart the job search. They would then be classified as "unemployed," pushing the unemployment rate up. At the same time, while growing, the economy might not create that many jobs, either.

The San Francisco Fed did research into trends in the labor-force-participation rate. It has fallen consistently since the late 1990s, reflecting the aging of baby boomers. But the trend has become much more pronounced during the recession and into the recovery as people abandoned their job searches and dropped out of the labor force. Some have gone back to school, others stayed home with the kids, and some have given up for the time being. Some of these people still want jobs but have stopped actively looking.

To put numbers onto this trend, nearly 6.9 million people report being out of the labor force but wanting a job. Based on historical averages, about 2.1 million of them could enter the job market as economic conditions improve. How long will it take them to re-enter the job market? In a scenario where it takes year and a half to join the labor force, the unemployment rate would stall at more than 8% by the end of next year. In this scenario, the unemployment rate could stay around 8% as late as mid-2014. On the other hand, if it takes three-and-a-half years for this group to join the labor force, the unemployment rate would stay at 7.7% through the end of next year. By comparison, if none of the 2.1 million potential workers were to enter the labor market, the unemployment rate could be projected to fall to 7.4% by the end of 2013.

How successful will they be at finding jobs? After all, they must compete for open positions with people with more recent job experience. Some, particularly discouraged workers, must explain to potential employers a possibly long gap in their work history. That isn't necessarily a deal-breaker, though, as other research from the San Francisco Fed shows the job-finding rate for the long-term unemployed has improved. Not coincidentally, the job-finding rate shows a marked increase around the time that extended unemployment benefits typically expire. Even so, the long-term unemployed have a much more difficult time in gaining employment than those with a shorter spell of joblessness.

Of course, what also matters is the type of job some re-entrants (or new entrants) will be seeking. Middle-skill, white-collar and blue-collar jobs have seen very little growth. Previous research has documented the hollowing out of these middle-class jobs, with more positions available at the high or low end of the pay/skills spectrum, and even fewer in between. That may keep some re-entrants from finding work, unless they either upgrade their skills or settle for lower-paying work.

What all of this means is that the unemployment rate may stay high until perhaps 2016 with the Fed keeping its current programs in place (this assumes no new recession in the meantime). The other side is that some of those who dropped out of the labor force to improve their skills or education may find it easier to regain employment.

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