Why the unemployment rate might soon stop falling

December 17, 2012

Over the past year, the U.S. unemployment rate has fallen rapidly, from 8.7 percent last November to 7.7 percent today. But a new paper from the Federal Reserve Bank of San Francisco suggests that this decline could soon stall out.


Lookin' for work again. (AP)

Why is that? Not because the U.S. economy is about to slow down. Rather, it's because a number of discouraged workers who had previously dropped out of the labor force may soon start searching for jobs again. That's good news for the economy, but it means that the official unemployment rate could flat-line for a year or two — even if the economy's improving.

Remember, the official unemployment rate only measures people who are part of the "labor force" — that is, people who either have jobs or are actively looking for work. Since 2007, the U.S. labor force participation rate has shrunk dramatically:

Economists disagree on why this is, exactly. Some of it is likely structural — Americans are getting older and the Baby Boomers are starting to retire. But somewhere between one-third and one-half appears to be cyclical: A number of workers have been discouraged by the crummy job market and have given up looking for work altogether. Right now, there are about 6.9 million Americans who aren't counted in the official unemployment rate but would still like a job.

The authors of the San Francisco Fed paper ask what will happen if those workers start searching for work again once the economy improves. Their best estimate is that about 2.1 million of them are likely to start seeking work at some point. If they come back to the workforce at a faster rate than they did during the late 1990s expansion, then the official U.S. unemployment rate will most likely stay above 8 percent through the end of 2013.

By contrast, if none of those 2.1 million discouraged workers starts looking for work again, then the unemployment rate could fall to 7.4 percent by the end of 2013. Most likely the real answer will be somewhere in between. But where?

This isn't just a theoretical question. The Federal Reserve has said that it plans to keep interest rates low until the U.S. unemployment rate gets down to 6.5 percent (or until inflation looks likely to top 2.5 percent). When we get there will partly depend on how many jobs the economy adds each month. But it will also depend on what all those currently discouraged workers decide to do.

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Ezra Klein · December 17, 2012