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March 22, 2011

The unemployment puzzle--or at least one of them

Brad DeLong (hat tip Mark Thoma) looks at the frustratingly slow progress in U.S. labor markets and offers an intriguing hypothesis about the changing nature of American recessions and recovery cycles. First, some relevant framing facts:

Between 1950 and 1990—back in the old days of Federal Reserve inflation-fighting recessions—the unemployment rate in the United States would on average close 32.4% of the gap between its initial value and its natural rate over the course of a year. If the United States unemployment rate had started to follow such a path after its fall 2009 peak, we would now have an unemployment rate of 8.3% instead of 8.9%.

"But there is the unfortunate fact that none of the United States net reduction in the unemployment rate over the past year comes from increases in the employment-to-population ratio, and all of it comes from decreases in labor force participation…

"…[W]e note that between 1950 and 1990—back in the old days of Federal Reserve inflation-fighting recessions—the employment to population rate in the United States would on average rise an extra 0.227 in a year for each year that the unemployment rate was above its natural rate. If the United States employment-to-population ratio had started to follow such a path after its fall 2009 peak, we would now have an employment-to-population ratio of 59.7% instead of 58.4%. It would indeed be morning in America, instead of the current economic state."

The reference to "the old days of Federal Reserve inflation-fighting" is the key to DeLong’s story of how recent recessions, and their aftermath, differ from most of our postwar experience:

"The obvious hypothesis for why this current recovery—and the last two recoveries—in the United States have proceeded at a sub-par pace is that the speed of recovery is linked to the causes of the downturn. A pre-1990 recession was triggered by a Federal Reserve decision that it was time to switch policy from business-as-usual to inflation-fighting. The Federal Reserve would then cause a liquidity squeeze and so distort the constellation of asset prices to make much construction, sizable amounts of other investment, and some consumption goods unaffordable to demand and hence unprofitable to produce. The resulting excess supply of goods, services, and labor would lead inflation to fall.

"After the Federal Reserve had achieved its inflation-fighting goal, however, it would end the liquidity squeeze. Asset prices and incomes would return to normal. And all the lines of business that had been profitable before the downturn would be profitable once again. From an entrepreneurial standpoint, therefore, the problems of recovery were straightforward: simply pick up where you left off and do what you had used to do.

"After the most recent downturn, however—and to a lesser extent after its two predecessors—things have been different. The downturn was not caused by a liquidity squeeze. The Federal Reserve cannot wave is [its] wand and return asset prices to their pre-downturn configuration. The entrepreneurial problems of recovery are much more complex: not to recall what it used to be profitable to produce but rather to figure out what new things it will be profitable to produce in the future."

I am sympathetic to this view as the dynamics of employment recoveries do seem much different in the post-1990 era than in the pre-1990 era. To provide yet another example, on average it took 10 months to recover all the jobs lost during the recessions of the period between 1950 and 1989. In contrast, it took 23 months to recover the jobs lost following the 1990–91 recession and 38 months following the 2001 recession. Right now we are 20 months from the official end of our most recent contraction and still almost 5.5 percent below the pre-recession employment peak. (A stark graphical reminder from Calculated Risk is featured at Economics Roundtable.)

What's more, the mechanism DeLong appeals to rings true. That is, prior to the 1980s, downturns in the economy were dominated by intentional tightening by the Federal Reserve to contain inflation. In the post-Volcker era, however, structural shocks appear to be the dominant story.

But the deeper one digs into the labor market facts, the deeper the questions become. Let me offer up an old macroblog favorite, the Beveridge curve. We have noted in the past that the Beveridge curve—which measures the relationship between the unemployment rate and job openings created by businesses (or vacancies)—seems to have shifted outward over the course of this recovery. In words, relative to the jobs available, unemployment is higher than we would have predicted based on the vacancy/unemployment relationship that prevailed in the 10 years prior to last year.

My view has been that this shifting of the Beveridge curve relationship represents structural issues in the U.S. labor market. A counterargument has been that such shifting is typical of the early phases of a recovery. And if the 1990-91 and 2001 recessions are the best analogs to the current cycle, we might well expect the relationship between job availability and unemployment to return to the prerecession norm as the efficiency of the job-matching process recovers along with other aspects of the economy. In fact, we might even expect the job-matching pace to improve over time as illustrated by the following chart that plots the time path of job openings and the unemployment rate (with the 1990–2001 and 2001–07 periods highlighted in green and red respectively):


The fact that all the points highlighted in green lie to the left of the points highlighted in red means that, for a given number of job openings, unemployment rates were lower during most of the past decade than they were in the 1990s. And there is certainly no evidence that outward shifts in the Beveridge curve are permanent.

Here, though, is where the search for unified business cycle theories gets a little tough. The return of the Beveridge curve to its prerecession norm is a distinctly post-1980 phenomenon. Excepting the 1960–61 episode, the recessions in the 1950–80 era are consistently associated with seemingly permanent rightward shifts in the Beveridge curve:


On the other hand, the aftermath of the inflation-fighting 1981–82 recession represented a clear shift, as the vacancy/unemployment relationship improved dramatically (albeit slowly):


How can we explain, then, that the supposedly demand-driven recessions of the pre-1990 era were associated with seemingly structural changes in the Beveridge curve relationship (in the "wrong" direction prior to 1980 episodes, in the "right" direction after the inflation-wringing contraction of 1981–82).

And what about this time around? Here's where we stand:


Is the recent shift in the Beveridge curve here to stay, or transitory as appears to have been the case in the last two recessions?

Can I get back to you on that?

Photo of Dave Altig By Dave Altig
Senior vice president and research director at the Atlanta Fed



An aside: A warm welcome to our new blogging brethren at the New York Fed's Liberty Street Economics.

Update: If you prefer your Beveridge curve history in movie form, Roger Farmer's your man.

March 22, 2011 in Employment, Federal Reserve and Monetary Policy, Labor Markets | Permalink

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Comments

I have no idea how a Beveridge curve is calculated. But I believe recessions pre 1990 were basically inventory related, so they were centered in the manufacturing sector. Since then, the recessions have been mainly in the service sector. Offshoring has also played a part.
Given the above, I'm surprised that the Beveridge curves in the earl '50's are simlar to the most recent curves.....

Posted by: stewart sprague | March 22, 2011 at 11:31 PM

you state the observables but dont seem to have any explanation as to what is driving them... there doesnt appear to be a hidden secret meaning... one possible answer seems to be quite straight forward and staring everyone right in the face.

if the yuan peg goes there will be 1) more jobs, 2) higher inflation, 3) probably more labor participation. if it does not there will be 1) fewer jobs, 2) accelerating inflation (but gradually so.. in line with reduced productivity of asia as their wages rise), 3) lower participation rates (aging population and baby boomers dropping out of the employment basket)

the 60s was a period of low inflation and excess capicity driven by an emerging japan... the 70s was when the world discovered that japan also wanted to consume western style, and the 80s was to adjust the global imbalances... which lead to higher inflation, blah blah blah...

so the beveridge curve went in one direction from the late 50s to 1980, then the other direction from 1980 to 1990... seems to me that in periods of low inflation the curve is to the lower left of the graph, and during periouds of higher inflation it is to the upper right. The inflation of the late 70s and early 80s was driven by commodities and bretton woods ( In February 1973 the Bretton Woods currency exchange markets closed, after a last-gasp devaluation of the dollar to $44/ounce, and reopened in March in a floating currency regime). The fact that his curve took a sharp shift to the upper right starting late last year gives me even more conviction that what we are seeing is the start of another inflationary push... a la 1970s... sadly the FED are still fighting the ghost of Japan past.... much of the timing behind this depends on the degree to which the yuan is allowed to adjust... will it be through internal inflation or will it be via a revaluation of the currency... either way it will result in inflation, and that inflation will make it more difficult to make things for local consumption half a planet away... so in the longer term i guess you will eventually see manufacturing moving back closer to consumption... but that will be very inflationary as it implies a normalisation of current imbalances... what we definately dont want is to let global imbalances continue any longer as they are massively destabilising... Geithner do your job and stop talking about it.

Posted by: Macroboy | March 23, 2011 at 08:24 AM

well, my view is that its the shifting nature of the US economy. As the US economy shifted from manufacturing-centric to service based, the inventory restocking phase of the business cycle has had less and less impact. Compare world industrial production and commodities prices ... definitely up since 2008. But this has had little impact on the US employment situation. In the 80s, as auto manufacturers brough people back to work, this would have a much larger impact.

service workers - especially skilled ones -are more like a fixed cost than a variable cost.

Posted by: dwb | March 23, 2011 at 09:55 AM

At some point my hope is a smart Grad student goes back to Alan Blinder's work on outsourcing. Specifically, the analysis I would to see performed is an update to Blinder's review of the job catergories identified at high risk of outsourcing.

My guess is that much of the sluggishness in labor demand is the result of offshoring.

Posted by: fladem | March 23, 2011 at 11:02 AM

"The entrepreneurial problems of recovery are much more complex: not to recall what it used to be profitable to produce but rather to figure out what new things it will be profitable to produce in the future."


The term for that is "structural unemployment", however much it may be denied.

Posted by: wally | March 24, 2011 at 09:10 AM

Great post, i've already subscribed to your feed. thanks

Posted by: Ganhar Dinheiro | March 28, 2011 at 08:24 PM

It's like these graphs are TRYING so hard to clarify, but ultimately just generating more confusion.

Surely there are better graphical ways to view slack labor supply and slack labor demand? Sure, each recession is idiosyncratic, but I don't think that needs to conclude it's all just a wash: I think that the graphs are holding you back

Posted by: fischer | April 01, 2011 at 07:20 PM

Good comments above that relate to my thesis -- the US is due for liquidation.

MANEMP/PAYEMS shows mfg falling from 30% in 1950 to under 10% today.

American labor can't compete with $15/day labor so something is going to have to give here eventually.

We tried to get through the previous decade by blowing a $7T+ debt bubble (CMDEBT), but that eventually failed since the housing sector is really consumption and not actual productive enterprise that can indefinitely support debt burdens on its own.

Since 2008 we've replaced the the home ATM with deficit spending: Total Public Debt, but this too is just a delaying tactic.

I don't know where things are going from here but I really think we passed a singularity with NAFTA and Chinese MFN, and to understand the next 20 years you need to understand what has been happening over the past 20.


Posted by: Troy | April 01, 2011 at 07:48 PM

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