Labor market slack attack

The Peterson Institute for International Economics hosted an event Wednesday titled “Labor Market Slack: Assessing and Addressing in Real Time.” The conference centered on understanding exactly why the weak U.S. labor market still plagues our economy more than five years after the end of the Great Recession.

The share of the population in the labor force has fallen considerably since the beginning of the Great Recession in December 2007. But what makes it difficult to measure this decline right now is whether the weak labor force participation rate is due to the effects of the Great Recession or to a long-term trend. The relative importance of these factors is still up for debate.

Simply put, there are two major reasons behind the decline in participation in the labor market. The first is, unsurprisingly, the effects of the Great Recession combined with the cyclical nature of the economy. Workers dropped out of the labor market because of economic weakness, but once the economy started growing again they started to re-enter the labor force. We’ve seen this happen in the U.S. labor market over the past year as growth has slowly drawn workers back in.

The other major factor is a long-run one: the aging of the Baby Boomer generation. As Americans born in the immediate postwar era reach their 60s, they are starting to retire and therefore are exiting the labor market. These workers would have dropped out regardless of the effects of the Great Recession. Or at least that’s the simple version of the story. (The more complex story is that the recession causes workers who would have retired in a few more years to retire early. So demographics are the primary cause, but the recession sparked an early exodus.)

The argument among economists is over how to assign degrees of responsibility to the different factors. A variety of studies attempt to decompose these effects. But agreement has yet to be found. A study from earlier this month by economists from the Board of Governors of the Federal Reserve System and the Cleveland Fed finds that almost all of the decline in the participation rate is due to structural factors such as aging. Yet there appear to be some concerns with the methodology of the study, which were aired at the Brookings Papers on Economic Activity conference early this month.

President Obama’s Council of Economic Advisers attempted a similar exercise in July. They found that that aging accounts for about half of the decreasing since the last quarter of 2007. About one-sixth of the decline is from cyclical factors. But interestingly, about one-third of the decline comes from “other factors.” In other words, one-third of this problem might come from long-term trends other than aging or the unique intensity of the Great Recession.

So even highly trained economists have difficult teasing out the difference between the two trends and at times they further complicate the story with other potential factors. Cardiff Garcia of FT Alphaville has pointed out that Federal Reserve chair Janet Yellen is keening aware of the lack of stark divide between cyclical and structural labor market factors. This indeterminacy affects other measures of slack such as wage growth. Policymakers, while not sailing blind, are still in a considerable amount of fog.

September 26, 2014

Connect with us!

Explore the Equitable Growth network of experts around the country and get answers to today's most pressing questions!

Get in Touch