Persistent Unemployment - The New Norm

It's quite apparent, despite the Fed's assurances otherwise, that this recovery has been a particularly tough one if you are an unemployed or underemployed American.  This recovery has felt far different than most of the recoveries that many of us have experienced throughout the past few decades.  A recent study by the Brookings Panel on Economic Activity suggests that this may well be the new norm in their paper "Amerisclerosis?  The Puzzle of Rising U.S. Unemployment Persistence" and that the post-Great Recession economy is simply following a pattern that was established after the previous two recessions where the recovery in employment follows a prolonged and somewhat flattened shape rather than the more traditional "V" shape experienced in the 1950s, 1960s, 1970s and early 1980s as you can see in this graphic:

In an average recession before the 1980s, unemployment peaked approximately one year after the start of the recession and had returned to the natural rate within four years of the start of the recession.  Within a single year of the peak rise of unemployment, approximately half of the rise in unemployment had been reversed.

Looking back at the period between 1979 and 1983, the U.S. unemployment rate surged by 4 percentage points and recovered most of its job losses by 1987.  In sharp contrast, countries in Western Europe that experienced roughly the same increase in joblessness saw their unemployment rate drop by only half a percentage point over the same time period.  Economists termed this phenomenon "hysteresis" which is defined as the lagging of an effect behind its cause, in this case, the persistence of unemployment over time.  It was also called Eurosclerosis.

Looking at today's jobless environment in the United States, we are seeing a similar phenomenon.  The unemployment rate after the Great Recession peaked at 10 percent; a rise of 5.5 percentage points over its post-2001 recession lows.  Within the first two years of the peak rise in unemployment, only about one-quarter of the rise in unemployment had been reversed, contrasting sharply with the experience of the 1950s to 1980s.  In the four years since the end of the last recession, the unemployment rate has only fallen halfway back to its pre-Great Recession levels (and, in any case, this is most likely overstated since a great deal of the drop in unemployment levels can be attributed to declining labor force participation rates).

In looking at the graph, you'll notice that with each post-recession recovery starting in 1990 - 1991, the period of jobs recovery becomes longer and longer.  It certainly appears that America is developing its own version of job sclerosis; Amerisclerosis.  This can quite clearly be seen in this graphic that compares the European version in 1980, the U.S. recovery in 1980 and the U.S. recovery after the 2008 recession that looks strikingly similar to the 1980 Eurosclerosis:

Why is this?  There are three possible factors that many economists have suggested as possible causes for prolonged high unemployment, including:

1.) Declining labor mobility.

2.) Changing age structures in the workforce.

3.) Declining trust among Americans and a changing perspective on claiming government benefits.

Research by the authors shows that declining labor mobility and changing age structure within the workforce do not explain the rising persistence of unemployment, in fact, a higher share of older workers relative to younger workers actually reduces the persistence of unemployment.  When a decline in the level of trust is combined with the aging of the workforce, there is an even greater decline in persistence rather than the increase experienced in 1990, 2001 and 2008.

The authors focussed on three key classes of explanations for the rising persistence in unemployment as follows:  

1.) The composition of shocks driving the American business cycle may have changed with some shocks having a more persistent impact on the economy.  Most post-World War II recessions were driven by the Federal Reserve's insistence on battling inflation.  As interest rates rose in response to inflationary pressures, the economy began to contract.  In the case of recent recessions, financial factors (shocks) have played a greater role, however, empirical evidence suggests that these factors cannot account for the rising persistence of unemployment in the U.S. even though they can account for most of the initial rise in unemployment and that a long sequence of shocks can contribute to excess persistence.

2.) Policy responses to business cycles may have changed.  This is particularly notable in this cycle where, for the first time, the Federal Reserve has lowered interest rates to the zero bound at the same time as government fiscal austerity creates lower spending levels.  Both of these factors contributed to the persistent joblessness in the 1990, 2001 and 2008 recessions in varying measure but do not explain the excess persistence when compared to earlier recessions.  In the case of the Great Recession, the Fed's zero interest rate policy is estimated to have contributed approximately 1.5 percentage points to the unemployment rate after four years.  In the case of the 1990 and 2001 recessions, contractionary fiscal and monetary policies led to a delayed decline in the unemployment rate compared to what would have been experienced had pre-1980 policies been followed.  In all three of the most recent recessions, it is clear that both Federal Reserve policies and government fiscal policies have had a relatively significant impact on prolonging joblessness.

3.) Changes in the propagation mechanisms of the economy including missing disinflation, the rise in long-term unemployment, the behaviour of regional labor markets and the changing cyclicality of disability claims.   The current low inflation environment hinders the downward adjustment of real wages that are needed to allow the labor market to adjust during a downturn i.e. one would expect to find a larger increase in the occurrence of zero percent wage increases in the three most recent recessions that accounts for the increased persistence in high unemployment levels.  The data does not lend credence to this theory.

As you can see, the problem of America's increasingly sclerotic employment environment is puzzling, however, a great deal of the persistence in unemployment can be explained by the contractionary monetary policies of the Federal Reserve and fiscal policies of the government.  Now that the Fed has backed itself into a policy corner and the federal government has backed itself into a debt corner, it seems more likely than ever that the American job market is experiencing a new reality of chronically high background unemployment.  It is also increasingly likely that there are more powerful and unidentified economic factors at work that suggest that persistently high unemployment after a recession is the new norm and that we'd better get used to it.