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July 15, 2005

How Much Slack in the Labor Market Today?

PGL at Angry Bear points me to Rex Nutting, who summarizes Katherine Bradbury's calculations on what the unemployment rate would be if labor force participation were behaving "normally":

Joblessness understated, Fed study says - Economy - Bond Market: Labor force participation rates have not rebounded By Rex Nutting, MarketWatch: The current low U.S. unemployment rate probably understates the true level of joblessness by 1 to 3 percentage points, the senior economist at the Boston Federal Reserve says. Millions of potential workers who dropped out of the labor force during the recession four years ago have not returned as expected and are thus not counted in the official unemployment statistics, said Katherine Bradbury in a paper published by the Boston Fed. The jobless rate fell to 5% in June the lowest level since the terror attacks of September 2001.

Labor force participation rates "have not recovered as much as usual and the discrepancies are large," she wrote. "Current low rates of labor market participation thus potentially represent considerable slack in the U.S. labor market," she wrote. The amount of slack in the economy is a key variable for Federal Reserve policymakers, who have been raising interest rates for more than a year to return rates to "neutral' levels. All things equal, the more slack in the economy, the lower rates ought to be.

Some policymakers have argued that the economy is close to full employment with the jobless rate at 5%, thus justifying higher rates to pre-empt inflationary pressures from building in a tight labor market. While the official unemployment rate has fallen from a peak of 6.3% in June 2003 to 5% in June 2005, the labor force participation rate remains close to 15-year lows of 66%....

All of the improvement in participation rates during this recovery has come from people over 55, as more relatively healthy Baby Boomers enter this cohort. At the same time, participation rates for teenagers have fallen to 44% after averaging more than 50% during the 1990s boom. If labor force participation rates had improved as much during this recovery as typical, between 1.6 million and 5.1 million more people would be in the labor force, Bradbury concluded. If those people were counted in the labor force but not working, the jobless rate would have been somewhere between 6.5% and 8.7%, rather than the 5.4% reported by the Labor Department in the three months from November 2004 to February 2005. "An 8.7% unemployment rate would represent considerable slack in the labor market," Bradbury said.

http://www.bos.frb.org/economic/ppb/2005/ppb052.pdf

As I say often, the pattern of long-term unemployment, labor force participation, anemic real wage gains, payroll employment numbers, and the behavior of weekly hours all suggest a weak labor market with considerable slack and unused labor resources. Only the unemployment rate tells a different story.

Why the unemployment rate tells a different story remains a great mystery.

Posted by DeLong at July 15, 2005 12:29 PM