Getting to Full Employment: The Impact of Labor Force Growth

May 4th, 2014 at 1:29 pm

It’s widely understood that the pace at which the US job market gets back to full employment—assuming it does so before the next downturn—is in part a function of the size of the labor force.  A larger labor force, the more jobs it will take per month to lower the jobless rate.

This a germane observation given that last month’s large decline in unemployment, from 6.7 to 6.3 percent, was wholly driven by an equally large decline in the lfpr (labor force participation rate).  As the WSJ pointed out last Friday, assuming the lfpr stays at its current post-recession low of 62.8%, if payrolls continue to grow at their average pace over the past three months—about 240K/month—the job market would hit the top of the Fed’s full employment unemployment rate of 5.6% in just six months (let’s label this monthly value MTFE: “months to full employment”).

Sounds good, right?  But—and this is no critique of the WSJ piece, which noted this point—that estimate is likely biased down due to the depressed lfpr.

The WSJ used this handy Atlanta Fed calculator to come up with the six month estimate and I’ll do the same to make the lfpr point.  The calculator allows you to plug in various assumptions and then spits out the number of payroll jobs we’d need to create per month to hit your specified unemployment rate.  My point is to look at how the MTFE increases changes when you plug in what I think is a more realistic lfpr.

If you take a three-month moving average of the lfpr—to smooth out the monthly bips and bops—you’ll find it’s down about three percentage points from its pre-recession peak, roughly 66% down to 63%.  There’s been considerable argumentation as to how much of that decline is structural, as in people leaving the labor force for good, say for retirement, and how much is cyclical, such that they’d come back once the job market tightens up some of higher wages beckon them back.   I review the arguments here, but let’s take what I’d say is a fairly conservative view and split the difference.

So, how does that six-month figure change when we add 1.5 points to the lfpr (i.e., set it at 64.3%) but keep everything else the same (i.e., still assume that full employment equals 5.6% unemployment)?  It goes up to a few months short of three years (see figure), well beyond the six months you get if you stick with the current lfpr.

If you then assume, as I’d argue you should, that full employment is closer to the lower end of the Fed’s range, 5.2% (and true full employment may well be lower than that), then it would take another five months to get there.

The current expansion is already middle-aged; another 40 or so months of growth would make it among the longest in the postwar period.  That may well occur, but there are two points to keep in mind here: first, a partial return to a more normal lfpr amidst steady payroll gains at their recent pace will significantly extend the time it takes to get back to full employment, and second, these weak, jobless recoveries, characterized in this latest case by severe policy neglect under the guise of austere fiscal policy, make it much harder to achieve full employment before the next recession.

One other point can be drawn from the Fed calculator that some of my readers will find corroborating (I’m thinking of those who worry about the impact of increased immigration in demand constrained periods, for example).  Economists who talk and think about full employment typically and mostly do so from the demand side.  But the pace of supply of course matters too and you can fool around with the calculator in this regard by juicing the rate at which the working-age population grows.

For example, let’s say that we take the population growth rate up from its current monthly moving average of 0.077% to its pre-recession rate of around 0.1%.  That too significantly lengthens the TTFE to a bit over four more years.  But basic macro dictates that faster growing population also increases demand, and we can incorporate this idea by boosting the job creation number, say from 240K per month to 280K, which brings the TTFE back down to three years.

Any way you cut it, even assuming the recent trend in payrolls sticks, unless you also accept that the labor force remains stuck in the basement and full employment is 5.6%, MTFE is a lot longer than six months.

 

fullNscen

Source: Atlanta Fed Calculator; jobs per month target held at ~240K except in last scenario.

Scenarios:
1) WSJ estimate (I get 7 mos, not 6, btw, but close enough)
2) Add 1.5 percentage points to current LFPR (62.8% to 64.3%)
3) Full employment unemployment rate 5.2% instead of 5.6%
4) Increase working-age population growth rate from 0.077% to 0.1%
5) Move jobs target from ~240K to ~280K.

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6 comments in reply to "Getting to Full Employment: The Impact of Labor Force Growth"

  1. Smith says:

    One should hope for continued expansion less the Republicans are handed a recession after 8 years of Democratic rule and mediocre economic performance. Could Democrats then run against Republican obstructionism causing the poor recovery and the recession? Of course not, it’s not in the public discourse, it’s not a topic of conversation, no one asks about the latest charges against Republicans, it’s not being used in framing issues for 2014. Maybe it will out of necessity, in time, over the popular minimum wage. But not so far.


  2. D. C. Sessions says:

    I don’t see where you get any expectation of rising (real) wages increasing the LFPR. Rising real wages are the one thing that’s totally guaranteed to have the Fed step on the brakes (they’ve basically not tolerated them for more than 30 years, after all.)


    • Smith says:

      If rising real wages cause the Fed to slow down the economy, this is self defeating (from a macro standpoint), as at least a partial restoration of wage equity is needed to continue growth. Rising real wages have to come from somewhere, either productivity or someone else’s share of of the economic pie. The .1% have been demanding all of the productivity growth for themselves so they resist any real wage increase. It’s a double whammy to the .1% as some wage increase is passed on to consumer, raising inflation and eroding the value of capital (because much of it is loaned at fixed rates).

      So my question is what is the real wage growth target the Fed will tolerate? If it is effectively below a certain threshold, one should respond with the need to restructure the Fed, making it less beholden to the banks, and more responsive to labor.
      What is the current threshold?
      What should it properly be?
      What is Yellen’s say in this?

      Saying it depends on the inflation response to the higher wages is wrong. Business will always try to match higher costs with higher prices and then some, made all the more easier with monopolies and oligopolies.

      Fighting inflation from higher wages sustains (and indeed may be a major cause or the major cause) of inequality.
      r>g is not true when wage-r>captial-r, right?


  3. wmitty says:

    It’s been 4 years since Joe (a three letter word: J-O-B-S) predicted that “some time in the next couple of months” the economy start adding 250,000 to 500,000 jobs a month. So, maybe Biden’s prediction has finally come to fruition. We’ll have to wait and see. It’s been 4 years, we can wait a few more months.


  4. urban legend says:

    In what possible way would concentrating on the 25-54 age group not eliminate virtually any cloudiness from potential “structural” issues? I am aware of absolutely nothing that would have changed the imperative to work for a living within that period of life. In 2000, the U.S. OECD employment rate — which I understand to correspond to the BLS’s employment-to-population ratio — was at or near the top among all major countries. (Major countries, of course, had higher rates than countries with more traditional cultures such as in southern European countries or those Eastern European counties emerging from Communism.) Now, we are near the bottom of the major countries, and it is hard to see how our culture differs enough to explain that drop in ranking.

    It is not hard to see, however, how depressed purchasing power among the mass of the population would contribute to inadequate demand to support a fully-functioning economy that can put everyone to work. Don’t all the naysayers who want to dig out this-and-that structural cause that can’t even pass basic empirical tests suffer — really, really, really suffer — from the most severe Occam’s Razor problems?


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