Academic journal article Economic Commentary (Cleveland)

Unemployment after the Recession: A New Natural Rate?

Academic journal article Economic Commentary (Cleveland)

Unemployment after the Recession: A New Natural Rate?

Article excerpt

The past recession has hit the labor market especially hard, and economists are wondering whether some fundamentals of the market have changed because of that blow. Many are suggesting that the natural rate of long-term unemployment-the level of unemployment an economy can't go below-has shifted permanently higher. We use a new measure that is based on the rates at which workers are finding and losing jobs and which provides a more accurate assessment of the natural rate. We find that the natural rate of unemployment has indeed shifted higher - but much less so than has been suggested. Surprising trends in both the job-finding and job-separation rates explain much about the current state of the unemployment rate.

Over the course of the last recession, the U.S. economy shrank by 4.15 percent. This large aggregate shock had equivalently large effects on the labor market. A total of 8.3 million jobs were lost, and the unemployment rate rose from 4.7 percent to a peak of 10.1 percent in late 2009. Currently, more than 14.5 million people are officially unemployed and many are underemployed. More striking is the length of time people remain unemployed. Unemployed workers stay out of work for 34 weeks on average now, about 50 percent longer than at previous cyclical peaks (see figure 1). These large effects of the aggregate shock on the labor market raise the question about how unemployment is likely to evolve during the recovery and over the longer run.

We examine trends in long-run unemployment to try to answer this question. Implicit in our approach is the idea of a natural rate of unemployment, that is, some level of unemployment that is unavoidable, even in good times or well-functioning markets. Economists attribute the rate to frictions in labor markets that prevent or slow down the allocation of unemployed workers to firms that are looking for employees. These frictions might take the form of skill-job mismatches, geographical mismatches, or the costs of recruitment and job search (see for instance, Rocheteau 2006). One critical question now emerging is whether the past recession has increased overall frictions- increasing the natural rate of unemployment.

Our analysis provides some evidence that a large part of the increase in the unemployment rate is likely temporary but that the underlying trend has inched up modestly over the recent cycle. We also find that the average duration of unemployment has been increasing in the United States, and this increase has played a major role in the recent rise of both the actual unemployment rate and the estimated natural rate. While it may seem strange that the underlying trend appears to have increased only slightly even though the actual unemployment rate has doubled, the reason for this is that a decline in job-finding rates has been offset by a decline in separation rates as well.

These results point to troubling developments for the labor market- especially when we factor in the large pool of underemployed workers that has accumulated and the potential loss of human capita! facing the long-term unemployed.

Job-Finding and Separation Rates and the Long-Run Trend of Unemployment

The unemployment rate is the main indicator of the health of the labor market, but it doesn't tell us everything we need to know about what is driving any changes we see. It reports only the number of workers who are unemployed as a fraction of the labor force. In any given month, however, some employed workers lose their jobs and some unemployed workers find jobs, leading to flows of workers in to and out of the unemployment pool. It is largely these flows that drive the overall unemployment rate, yet the unemployment rate says nothing about them. To learn more about these flows, we track job-separation and job-finding rates, the average rates at which each of the flows occurs.

These flows generally follow a pattern in a typical business cycle. As the economy enters a downturn, separations start rising and job-finding rates start failing. …

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