Academic journal article Economic Perspectives

Employment Growth: Cyclical Movements or Structural Change?

Academic journal article Economic Perspectives

Employment Growth: Cyclical Movements or Structural Change?

Article excerpt

Introduction and summary

The Federal Reserve, in its policy analysis, must carefully weigh incoming data and evaluate likely future outcomes before determining how best to obtain its twin goals of employment growing at potential and price stability. It is tempting to regard high or rising unemployment as a sign of a weak economy. And, normally, a weak economy is one with little inflationary pressure and, therefore, room for expansionary monetary policy to stimulate growth. But unemployment is influenced by more than simply aggregate conditions. in a dynamic economy that responds to changing opportunities, some industries are shrinking while others are growing. Labor must flow from declining industries to expanding ones. This adjustment takes time. it takes time for employees in declining sectors to learn about new opportunities in other industries, acquire necessary skills, apply for job openings, and potentially relocate. And during this period of adjustment, the unemployment rate rises as waning industries lay off workers. Thus, the unemployment rate may increase or decrease, even though the aggregate state of the economy remains stable, simply because the labor market adjusts to shifting patterns of production.

For policymakers, it is essential to decipher what portion of a rising unemployment rate is due to a cyclical slowdown in which many sectors of the economy are simultaneously affected, as opposed to a structural realignment in production in which particular sectors of the economy are affected. The two factors ideally should result in different policy responses. If unemployment is rising because of a weak economy, the textbook response is for the Fed to take a more accommodative policy stance. If, instead, the unemployment rate is rising because of underlying compositional shifts in employment, an easing of monetary policy may discourage declining industries from contracting by keeping them marginally profitable, impeding the adjustment process. Furthermore, this policy may also encourage inflation as employers across a broad spectrum of industries compete for scarce labor resources. Thus, comprehending the underlying sources of movements in the unemployment rate is more than just a theoretical exercise: It has practical implications for monetary policy.

As a first step toward evaluating the role of structural change, I need to be able to measure it. Lilien (1982) suggests a dispersion measure that is a weighted average of squared deviations of industry employment growth rates from aggregate employment growth. Abraham and Katz (1986) argue that Lilien's measure does not properly account for cyclical shifts in employment across industries, instead conflating cyclical variation with structural change. When aggregate economic conditions are weak, certain sectors are affected more than others because demand for their products is more cyclically sensitive, but as soon as economic conditions improve, these sectors will also recover more quickly. The Lilien measure more accurately captures both cyclical variation in employment responses and structural changes in the composition of employment across industries, making it impossible to disentangle the importance of the two effects on the measure of dispersion.

The sectoral shifts hypothesis has been revisited more recently by Phelan and Trejos (2000) and Bloom, Floetotto, and Jaimovich (2009). Phelan and Trejos (2000) calibrate a job creation/job destruction model to data from the U.S. labor market to suggest that permanent changes in sectoral composition can precipitate aggregate economic downturns. Bloom, Floetotto, and Jaimovich (2009) examine the effect of what they term "uncertainty shocks" on business cycle dynamics, arguing that increases in uncertainty lead to a decline in economic activity in affected industries, followed by a rebound. Increasing uncertainty, in their view, causes firms to be more cautious in their hiring and investment decisions and impedes the reallocation of capital across sectors. …

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