Why is the Unemployment Rate Declining So Rapidly?

25 Sep. 2013 | Comments (2)

During the four years since the end of the recession, Gross Domestic Product (GDP) in the U.S. has risen slightly over 2% per year, by far the weakest recovery in the post-war era. One surprising feature of this recovery is that despite the weak economic growth, the unemployment rate has been declining rapidly. During the 46 months since the peak unemployment rate of 10% in 2009, the unemployment rate has declined by 2.7%. This decrease is faster than the unemployment rate declines of the previous two recoveries, despite GDP growing much faster during those recoveries than in the current one.

There are three possible explanations for this rapid decline in the unemployment rate during the current weak recovery. The first is related to productivity. Employers can increase production by either adding workers or increasing productivity of existing workers. From the mid-1990’s until the last three years, employers in the non-farm business sector have increased the productivity of their workers by almost 2.5% per year. However, during the past three years, productivity growth averaged only 0.8% per year.  The flip side of weak productivity growth is employers have been adding jobs at a solid pace. 

The second explanation is that during the last four years the baby boomers have reached retirement age and have begun leaving the work force at an accelerated pace. This has opened jobs for job seekers, thereby lowering the unemployment rate.

Third, among younger workers, more have been choosing not to work. Among the population aged 25 to 54, the percent of Americans who are not in the labor force, which is defined as those who are not workers or active job-seekers for various reasons, increased from 17.5% in October 2009 to 19% in August 2013. The smaller number of people competing for jobs has contributed to the declining unemployment rate.

A critical question is whether the rapidly falling unemployment rate is likely to continue. The future depends on the trajectory of productivity, retirement, and labor force participation, as well as the rate of GDP growth in the coming years.

The trend of productivity growth is intensely debated by economists. It is unclear whether weak productivity growth during the last three years reflects a lower trend or is a temporary blip. The truth is probably somewhere in the middle. Productivity during the next few years is likely to grow faster than the immediate past, but is unlikely to reach the rapid growth rates of 1995 to 2010.

The rapid retirement of the baby boomers is certain to continue for at least one more decade, which will continue to put downward pressure on the unemployment rate. Regarding the participation rate of younger people, as the labor market continues to improve, it would be surprising if the participation rate continues to decline. 

Perhaps the most important factor will be the rate of economic growth. Most economists expect GDP to grow significantly faster during the next few years than during the previous four years. All in all, the rapid decline in the unemployment rate is likely to continue in the coming years. This is good news for job seekers who will increasingly be more likely to find a job. 

On the other hand, employers will find it more difficult to find qualified workers as the unemployment rate continues to decline. While it is now probably easier to find qualified workers than before the recession, evidence suggests that the unemployment rate is under-estimating the difficulty of finding qualified workers. More than at any other time in the post-war era, job seekers include workers who have not been practicing their skills for long periods of time (due to long periods of unemployment or underemployment), and are, therefore, considered less qualified by potential employers.

Finally, the rapid decline in the unemployment rate will have implications for monetary policy. In late 2012, the Federal Reserve announced that it intends to keep interest rates near zero, at least until the unemployment rate reaches 6.5%. Most economist at that time thought that this would happen in 2015 or 2016. Given that we are already at an unemployment rate of 7.3%, it is possible that we will reach 6.5% in 2014.

The divergence between GDP and the unemployment rate in this recovery suggests that the unemployment rate may be over-estimating the strength of the U.S. economy. When we get to 6.5 percent, the economy may be weaker than what the Federal Reserve originally hoped for when setting this target. In several speeches over the past year, a number of senior Fed officials alluded to that by downplaying the importance of the unemployment rate in their decision. In sum, even after reaching 6.5 percent, it may take a while before the Fed starts raising rates again.

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  • About the Author: Gad Levanon, Ph.D.

    Gad Levanon, Ph.D. Gad Levanon is director of macroeconomic research at The Conference Board, where he also leads the labor markets program. He also serves on The Demand Institute™ leadership team. Levanon create…

    Full Bio | More from Gad Levanon, Ph.D.

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  1. Rita Shor 0 people like this 01 Oct. 2013 10:49 AM

    Gad,

    This explanation is really clear and makes it easy to quote TCB's insight when talking to council members and other professional colleagues. This is content virtually everyone cares about. Thank you.

  2. Daniel Petro Jr 0 people like this 02 Oct. 2013 02:13 PM

    Gad
    Concerning your comment about how more and more younger workers are choosing not to work and enter the workforce, what are your thoughts as to why?

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