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The unemployment puzzle

Publishing date
24 March 2011

What’s at stake

For the fourth consecutive week, the U.S. Department of Labour revealed that the 4-week moving average of weekly unemployment insurance claims is below the 400,000 level. Although this is a small positive step for the labor market as pointed out by Calculated Risk, the slow progress in U.S. and other advanced economies’ labour markets remains frustrating.

Jobless recoveries and the changing nature of recessions

Dave Altig
points that on average it took 10 months to recover all the jobs lost during the recessions of the period between 1950 and 1989. In contrast, it took 23 months to recover the jobs lost following the 1990–91 recession and 38 months following the 2001 recession. Right now we are 20 months from the official end of our most recent contraction and still almost 5.5 percent below the pre-recession employment peak.

Brad DeLong offers a hypothesis about the changing nature of American recessions and recovery cycles. A pre-1990 recession was triggered by a Federal Reserve decision that it was time to switch policy from business-as-usual to inflation-fighting. After the Federal Reserve had achieved its inflation-fighting goal, however, it would end the liquidity squeeze. Asset prices and incomes would return to normal. And all the lines of business that had been profitable before the downturn would be profitable once again. After the most recent downturn, however—and to a lesser extent after its two predecessors—things have been different. The downturn was not caused by a liquidity squeeze. The Federal Reserve cannot wave is [its] wand and return asset prices to their pre-downturn configuration. The entrepreneurial problems of recovery are much more complex: not to recall what it used to be profitable to produce but rather to figure out what new things it will be profitable to produce in the future.

Jobless recoveries and breakdowns in Okun’s Law

Real Time Economics
argues that Okun’s law – the relationship between GDP growth and changes in unemployment – might be breaking down in the other direction. The economy’s growth rate picked up by around a percentage point in the second half of last year, from 1.7% in the second quarter to 2.8% in the fourth quarter, and it might be going a bit faster than that now. Despite the relatively small shift in output, unemployment seems to be falling sharply. In three months it has fallen by nearly a full percentage point to 8.9%. It’s still early days for the improvement, but it raises questions. Why did the drop in output cause such a big rise in unemployment during the downturn? And why is an apparently small increase in output now causing unemployment to fall so quickly? One possibility is that worker productivity explained the unemployment surge in 2008 and 2009 but that something else is driving unemployment down now. One possibility is that now, worn down by years of bleak job prospects, people are simply dropping out of the labor force. As labor force participation falls, the number of people counted as unemployed drops and holds down the unemployment rate. In other words, the numbers look better but the job market isn’t actually improving that much. Supporting this theory is the fact that the labor force participation rate has dropped from 64.8% a year ago to 64.2% today, its lowest level since 1982.

Scott Sumner argues that the entire concept of “jobless recoveries” is largely a myth. What I see isn’t jobless recoveries, but three consecutive recessions where the first 6 quarters saw no recovery at all (relative to trend.)  We fell into three deep holes, and started digging sideways. So yes, the last three recessions have been quite different, but the difference was that during the first 6 quarters of “recovery” there was no recovery at all. The real question is why did real GDP rise so slowly during the three most recent recoveries.

Policy complacency and unemployment

Christina Romer
says that she does not understand why policy makers aren’t more worried about the suffering of real families. There are tools that we can use, it’s shameful that we’re not using them. That goes all the way up to the Federal Reserve, which could be taking more aggressive action. It goes to the Congress and the Administration – there are fiscal policy actions they could be taking. And don’t tell me you can’t take those actions because of the deficit because I think there are fiscally responsible ways. David Romer also points that despite the deterioration in the current outlook for unemployment compared to that of late 2008, the dire sense of urgency has not increased. Indeed, it has largely disappeared.

Bruegel Economic Blogs Review is an information service that surveys external blogs. It does not survey Bruegel’s own publications, nor does it include comments by Bruegel authors.

About the authors

  • Jérémie Cohen-Setton

    Jérémie Cohen-Setton is a Research Fellow at the Peterson Institute for International Economics. Jérémie received his PhD in Economics from U.C. Berkeley and worked previously with Goldman Sachs Global Economic Research, HM Treasury, and Bruegel. At Bruegel, he was Research Assistant to Director Jean Pisani-Ferry and President Mario Monti. He also shaped and developed the Bruegel Economic Blogs Review.

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