- The Washington Times - Tuesday, March 10, 2009



A half-million surge in labor force growth last month added almost as much to unemployment as the sharp falloff in jobs. The jobless rate jumped up a half point in February, to 8.1 percent, the second time in the current recession (last May was the first) it rose by such a large amount. Looking back, it’s been 23 years since the unemployment rate rose that much in a single month.

Labor force behavior has changed, not surprisingly. A smaller proportion of the jobless are dropping out of the labor force in the current recession than in past recessions, which is pushing up the unemployment rate. If the unemployed this time around had left the work force at a rate consistent with past recessions, the loss in jobs in the past 14 months would have resulted an unemployment rate last month of around 7.5 percent, more than a half point below the actual rate.

It’s not incontrovertible that job loss depresses jobseeking. There are forces working in opposite directions to deflate or inflate the size of the labor force over the course of the business cycle, which in turn affects the unemployment rate. Economists call the opposing influences the “additional worker effect” and the “discouraged worker effect.”

Households can respond two ways to a loss in jobs. If the main breadwinner becomes unemployed, other members of the household can try to compensate for the loss in wages by also entering the labor force to search for a job. The effect is to raise the labor force participation rate (the additional worker effect).

Conversely, if additional household members do not enter the labor market and the unemployed breadwinner becomes discouraged and drops out of the work force because of the job shortage, the effect is to shrink the labor force (the discouraged worker effect.)

Research has shown that the discouraged worker effect tends to be the dominant cyclical force, i.e., on balance, labor force participation is pro-cyclical, rising and falling with changes in job opportunities. That means in the current recession the proportion of the working-age population in the labor force should be shrinking. And it is, only not by as much as models based on postwar experience would predict. Consequently, the unemployment rate is higher than history would predict. Why?

Three economists at the Federal Reserve Bank of San Francisco have examined the effects of declines in household wealth and credit on labor force entrants. Writing in the Jan. 30 issue of the Bank’s Economic Letter, Mary Daly, Bart Hobijn and Joyce Kwok “find evidence suggestive that sharply reduced wealth and liquidity are prompting certain demographic groups to enter the labor force in greater numbers.”

The authors note that, unlike the current downturn, neither of the two prior recessions, in the early 1990s and in 2001, “saw the combination of substantial declines in financial markets and house prices accompanied by severe tightening of credit conditions for average households.” Consequently, consumption held up in the prior recessions and households had access to resources to finance activities outside the labor force. “By contrast, in the current downturn, the decline in wealth and credit availability is nearly unprecedented.”

Is it any wonder, then, that such powerful pressures on labor supply are pushing up unemployment to levels above what even the sharp job losses in the current recession would have predicted?

Looking forward, say the authors, the “inflow of workers into the labor market could cause unemployment rates to exceed forecasts. …”

That’s already happening. Private sector economists are lowering their output forecasts and raising their unemployment forecasts, with the administration’s more optimistic projections tailing behind. And there’s reason to believe the latest round of more pessimistic forecasts will also prove to be too optimistic.

St. Louis Federal Reserve Bank economist, Michael W. McCracken, has written a revealing article in the Bank’s February issue of National Economic Trends: “How Accurate Are Forecasts in a Recession?”

The author systematically analyzed professional economic forecasts of GDP and unemployment in downturns and expansions going back to 1981. He found that during recessions forecast errors were “four times larger than those made when the economy is not in a recession. … Forecasts of GDP growth and the unemployment rate both generally tend to be overly optimistic: Forecasts of GDP growth tend to be too high, whereas those for the unemployment rate tend to be too low.”

These are hardly cheery findings, especially at a time when economic policymaking is taking on the look of blindman’s buff.

Alfred Tella is former Georgetown University research professor of economics.

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