Returning to Full Employment in US – A CRS Report

Until recently, the economy and labor market were experiencing an unusually slow recovery from the longest and deepest recession since the Great Depression compared to other expansions since World War II. The rapid decline in the unemployment rate from 7.9% in January to 6.7% in December 2013 (where it remained in the first quarter of 2014) would seem to indicate that the labor market is returning to normal. The current unemployment rate is only 0.5 to 1.5 percentage points higher than the consensus range of full employment.

Unusually, the unemployment rate may not currently be a good proxy for the overall state of the labor market or economy. Some of the decline in the unemployment rate in 2013 is attributable to a recovery in employment, but some is attributable to workers dropping out of the labor force. The labor force participation rate has continued to fall during the recovery and is at its lowest level since the 1970s. In fact, it has fallen more in the past five years than at any time since data have been collected. Studies have identified multiple reasons for the decline. Some workers have left the labor force because they have become discouraged and given up on seeking employment. Others have left for reasons stemming from long-term trends that are unrelated to the recession, such as age or enrollment in school or training. This trend could reverse—for example, more workers returned to the labor force than found jobs in the first quarter of 2014, which prevented the unemployment rate from falling.

Other evidence also points to more slack in the economy than the headline unemployment rate suggests. Economic output and employment have grown since mid-2009 and 2010, respectively, but at relatively sluggish rates. The long-term unemployment rate and youth unemployment rates have fallen only modestly since the recession ended and are still at historically high levels. Inflation has remained slightly lower than the Federal Reserve’s (Fed’s) goal of 2%.

These other economic indicators could be sending a misleading signal about significant slack in the economy, however, if the economy’s potential capacity has been eroded by structural changes or by the length and depth of the Great Recession. Cyclical deterioration in the U.S. labor market is usually considered temporary—recessions are thought to have no lasting effect on overall employment and unemployment rates. This recession could cause a departure from conventional wisdom if labor market problems that started as cyclical persisted so long that they became structural. For example, long-term unemployment could have caused workers’ skills to erode, which would then prevent them from finding a job when the economy recovered.

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Employment has not returned to its peak because the decline in employment during the recession was so great, and because the rate of employment growth during the recovery has been relatively tepid compared to other recoveries, particularly those that followed deep recessions. Figure 1 shows that the average monthly job loss was much greater from 2008 to 2010 than in the three preceding episodes (1982, 1991, 2002 to 2003), where recessions caused employment to fall. It also shows that average monthly job growth in this recovery was much lower than in the 1980s or 1990s expansions, and comparable to the 2000s expansion, even though far fewer jobs were lost in 2002 and 2003.

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The labor force participation rate (LFPR) is the share of the population that is employed or unemployed. As can be seen in Figure 2, the LFPR hovered around 59% from after World War II to the late 1960s. It then experienced a long upward trend primarily because of the increased participation of women in the labor force, peaking at 67% in the late 1990s. Following the 2001 recession, it fell to 66%, where it remained until the Great Recession began.14 Since 2008, it has continued to fall, and stood at 62.8% at the end of 2013.

This decline is unprecedented.

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