Is Jobless Rate Really Falling?

(Originally published here.)

Over the past four years, the U.S.unemployment rate has fallen to 7 percent from a peak of 10 percent. Much of this progress may not be real. Sadly, the data in tomorrow’s job report won’t help us figure out the true state of the labor market.

About 6.5 million jobs have been added since the trough four years ago even as more than 11 million people have given up looking for work. Those people still exist even if they aren’t counted in the unemployment number, which is why theemployment-population ratio hasn’t really increased since the worst of the crisis. On the other hand, baby boomers started becoming eligible for Social Security benefits in 2008, so some people are dropping out of the labor force for benign reasons.

If this confuses you, don’t worry: Theminutes from the Federal Reserve’s latest meeting, which were released yesterday, indicate that America’s monetary policy makers are also unsure what the data really mean.

Aging and retirement explain some of the decline in the number of people looking for work. But that is an insufficient explanation for the broad reduction in the number of Americans in the labor force. Just comparethe labor force participation rate for people aged 55 years and up with the rate for those aged 25 to 54. As you can see, older Americans have maintained their pre-crisis participation rate even as the rate of adults in their prime working years has fallen by more than 2 percentage points:

Civilian labor-force participation rate, by age. Source: Federal Reserve Bank of St. Louis

Civilian labor-force participation rate, by age. Source: Federal Reserve Bank of St. Louis

One consequence of this decline is that the employment-population ratio for 25-54 year-olds has barely recovered from its crisis trough even though theunemployment rate for this age cohort has plunged to a little more than 6 percent from a peak of more that 9 percent. A pair of Fed economists recently found a clever way to interpret these data by comparing changes in prime-age labor participation across states. It turns out that the states with the biggest declines in labor- force participation are also the same states that had the biggest increases in unemployment at the beginning of the recession.

Civilian labor-force participation rate by state. Source: Christopher J. Erceg and Andrew T. Levin

Civilian labor-force participation rate by state. Source: Christopher J. Erceg and Andrew T. Levin

The researchers use this finding to conclude that the true “employment gap has only narrowed modestly over the past several years, because the steady widening of the participation gap has been comparable in magnitude to the decline in the unemployment gap.”

In case you thought this settled the argument, a contrary view comes from a recent paper by an economist at the Federal Reserve Bank of Philadelphia. Shigeru Fujita looked at the reasons people gave for leaving the labor force and found that most either retired or went on disability. According to Fujita, “the decline in the participation rate since the first quarter of 2012 is entirely accounted for by increases in nonparticipation due to retirement.”

He says that this will become even more extreme as the economy recovers. Unlike most Americans, the participation rate for those aged 65 and older has increased substantially since the start of the recession, almost certainly because the huge decline in house and stock prices made it necessary to delay retirement. That means that a significant fraction of the 8 million elderly Americans with jobs might leave the labor force if asset prices keep rising. One irony is that the Fed’s policies are partly predicated on the notion that rising asset prices increase, not decrease, the number of people working.

So who is right? It’s possible that people in their early 50s are starting to retire en masse but it is difficult to believe that story without additional information. Then again, how else can one explain the survey results identified by Fujita? It looks like the mystery may remain unsolved for quite some time.

(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)


About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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