Unemployment falling for wrong reason creates Fed predicament

Divided Economists

Central bank economists are divided over how much of the fall in the workforce is structural and thus not likely to be reversed.

“There is disagreement within the system,” said Geoffrey Tootell, senior vice president and director of research at the Federal Reserve Bank of Boston.

A July 2013 paper by Boston Fed economists Michelle Barnes, Fabia Gumbau-Brisa and Giovanni Olivei concluded that a significant portion of the drop since the start of the last recession results from demographic and other developments that probably will persist.

“About two-thirds of the decline has been trend” due to secular forces, Olivei said. He reckons the participation rate now is about three-quarters of a percentage point below where it otherwise would be because of temporary forces stemming from the 2007-09 recession and the muted recovery since then.

His estimate contrasts with research by Julie Hotchkiss, a senior adviser at the Atlanta Fed. In a paper with Georgia State University’s Fernando Rios-Avila that was published in March, she argues that cyclical influences are all-important in explaining the shrinkage in the labor force.

Fed’s Forecast

If the labor market recovers to pre-recession levels, the participation rate over the years 2015 to 2017 will average a about third of a percentage point more than it did from 2010 through 2012, they found. That would put it at 64.5%.

At that level, payrolls would have to rise close to 425,000 per month for the Fed to achieve its forecast of 7% unemployment by the middle of next year, according to a jobs- calculation formula developed by Atlanta Fed economists.

If participation held steady at its current level, payrolls would have to increase about 142,000 a month. The average so far this year has been 180,250.

The continued contraction in the number of workers, even as the job market improves, is raising questions at the Fed about how much of the shrinkage is temporary and will be unwound, said Michael Feroli, a former central-bank researcher who is now chief U.S. economist at JPMorgan Chase & Co. in New York.

Shifting Consensus

He said the consensus within the central bank seems to be shifting toward seeing the fall as more long-lasting and structural than cyclical.

“More and more, that seems to be the way they’re going,” he said.

The central bank’s policy-making Federal Open Market Committee will decide to begin reducing its monthly asset purchases at its next meeting on Sept. 17-18, according to economists surveyed by Bloomberg News.

Mary Daly, group vice president and associate director of research at the Federal Reserve Bank of San Francisco, said she now estimates that about 60% of the fall in participation since 2008 is because of structural forces, including the aging population. Previously, she had put that share at 50%.

More people than she expected are leaving the workforce because they’ve become permanently disabled, while fewer spouses of working Americans are rejoining.

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