Where is Unemployment Headed in 2013?

Research by the Federal Reserve Bank of San Francisco examines the Bureau of Labor Statistics (BLS) projections for medium-term labor force participation, an issue that will have a significant impact on the unemployment trend over the coming year.  With the still elevated post-recession unemployment rate and the Fed's future interest rate policies dependent on a further improvement in employment, the future of employment is key to the continued "recovery".

Labor force participation is defined as the proportion of the population that is either actively working or actively looking for work.  Long-term changes in labor force participation are related to several issues; demographic (i.e. retiring workers), cultural and institutional trends can impact the participation rate as can the business cycle, although, according to Willem Van Zandweghe, the correlation between the business cycle and the participation rate is somewhat less significant.  

From FRED, here is a graph showing the change in labor force participation since 1948 for men:

Here is the same data for women showing the increase in participation during the post-war era as women made the choice to enter the workforce en masse:

Here is the overall labor force participation rate for both genders:

The current labor force participation rate is 63.4 percent, down from its peak of 68.1 percent in July 1997 and its pre-Great Recession peak of 66.9 percent in July 2006.

The labor force participation rate varies by gender (as you saw in the previous graphs) but it also varies by age and ethnicity.  Younger and older workers participate at lower rates and Hispanic males participate at higher rates than their African-American and white counterparts.

While the business cycle may not have a huge impact on the participation rate compared to the slow changes seen over generations, during downturns, unemployed workers may choose to leave the workforce because they are discouraged or because they are seeking training for new skills.  Some economists suggest that at least one-third to one-half of the drop in the participation rate over this economic cycle was due to the weak labor market related to the Great Recession.

Here is a graph showing the rather steep drop in the labour force participation rate since the Great Recession:

To me, this suggests that the Great Recession had a greater than normal negative impact on the labor force participation rate, particularly when you look at the steepness of the drop in the multi-decade graph. 

From the monthly Current Population Survey data, here is a graph showing the percentage of individuals in American households who are out of the labor force that are looking for work:

Roughly 2.8 percent of Americans without work currently want a job.  This is a markedly elevated rate compared to the 2.2 percent who wanted a job after the 2001 recession and the 2.1 percent of non-working Americans who wanted a job between December 2001 and November 2007.  Right now, nearly 7 million Americans report being out of the labor force but wanting a job.  Historical data suggests that about 2.1 million of them could enter the workforce, by either getting a job or joining the masses of the unemployed that are looking for work.  With this in mind, let's look at three potential scenarios for these 2.1 million new entrants and their impact on the unemployment rate to the end of 2013:

1.) If these workers take a year and a half to join the labor market, the unemployment rate would stall at 8 percent by the end of 2013.  

2.) If it takes three and a half years for this group to join the labor market, the unemployment rate would stay at 7.7 percent through to the end of 2013.

3.) If none of these workers enter the labor market, the unemployment rate would fall to 7.4 percent by the end of 2013.  This is the least likely scenario of the three.

The potential entry of 2.1 million Americans into the country's labor market will most likely have a significant impact on the ability of the economy (and the Fed) to push the unemployment rate any lower than it already is.  This will have a marked psychological effect on consumers who are responsible for a growing share of U.S. economic output as shown here:

If you're out of work, you're far less likely to consume.  If you enter the labor market and have to wait for years to get a job, you're less likely to consume.

Since Mr. Bernanke is hinging the future of his entire loose money policy on reaching the magical 6.5 percent unemployment rate, it would certainly appear that ultra-low interest rates are here to stay for the long-term, particularly if the work force participation rate rises.