Admittedly, on the surface, employment statistics are certainly looking better than they did as little as 12 months ago. That said, there are issues facing the American jobs market that will make it difficult for the improvement to continue, particularly when one considers job growth rates and how they relate to labour force participation and population growth. A recent Letter by the Federal Reserve Bank of Chicago examines the relationship between these issues and looks at various scenarios that will close the gap between actual payroll employment and current estimates of employment growth. This is particularly critical to the economy since the Fed has linked its monetary policy to the country's employment data. As you will see, there are four key factors that the Fed examines to predict the ultimate rate of trend employment growth; labour force participation rate, population growth rate, the natural rate of unemployment and the trend ratio of payroll to household survey unemployment. I'll look at each factor in turn.
1.) Labour Force Participation Rate: Here is a graph showing the historical, current and projected drop in labour force participation rate:
Labour force participation rate measures the percentage of the civilian non-institutional population 16 years of age and older that is currently employed or actively looking for employment. Notice that the trend shows a marked drop in participation from 67 percent in the early part of the new millennium to a projected range of 62 to 63 percent by 2020, dropping an average of 0.3 percentage points each year.
2.) Population Growth Rate: Here is a graph showing overall historical, current and projected population growth rate:
Population growth climbed throughout the 1990s, peaking in the early years of the new millennium at 1.25 percent annually. It decelerated after that point, reaching about 1 percent annually on average, excluding the data from 2010 and 2011. It is expected that population will fall until 218 and then continue to grow at about 0.8 percent annually.
3.) Natural Rate of Unemployment: Here is a graph showing the natural rate of unemployment (blue line) and the actual rate of unemployment:
The natural rate of unemployment represents the unemployment rate that the economy would experience if it was making full use of its resources (think of it as the best case unemployment rate). This rate declined from 6 percent in the late 1980s to 5 percent by the new millennium and then rose to 6.25 percent during the Great Recession.
4.) Ratio of Payroll to Household Employment: Here is a graph showing the ratio of payroll to household employment:
The trend ratio of payroll to household employment is now stable at around 94 percent after a long climb from 91 percent to a peak of between 96 and 97 percent in the late 1990s. This factor is expected to remain at around the 94 percent level over the next few years.
As I noted in the first paragraph, Fed economists use these four factors to calculate the trend employment growth rate for the past, present and future. Let's look at that now.
Here is a bar graph showing the trend payroll employment growth rate from 1988 to 2020:
Trend employment grew at about 150,000 jobs per month during the late 1980s and early 1990s and by 200,000 jobs per month during the halcyon years of the mid- to late-1990s for these reasons:
1.) an increase in the labour force participation rate.
2.) an increase in the rate of population growth.
3.) a decline in the natural rate of unemployment.
4.) An increase in the ratio of payroll to household survey employment.
During the early 2000s, the trend employment growth rate fell to under 100,000 jobs per month. During the Great Recession, the trend employment growth rate fell by nearly 50,000 jobs per month in 2008 and 15,000 jobs per month in 2009. Since the "recovery", trend employment growth has averaged about 100,000 jobs per month, however, as the graph shows, trend employment growth is expected to slow to 80,000 jobs per month over the next two years and to 35,000 jobs per month between 2016 and 2020. This slowdown is based on:
1.) a decrease in the labour force participation rate.
2.) a slowdown in the rate of population growth.
Putting all of this data into the Fed's black box results in widely differing projections for future trend employment growth as follows:
1.) the most optimistic assumptions result in trend employment growth of 120,000 jobs per month over the last half of this decade (this is the level experienced in 2012).
2.) the most pessimistic assumptions result in trend employment growth of basically zero jobs per month over the last half of this decade.
3.) the most reasonable assumptions result in trend employment growth of around 35,000 jobs per month with a range of between 20,000 and 50,000 per month over the last half of this decade.
To summarize, at this point in time, employment growth of around 80,000 jobs per month would put downward pressure on the unemployment rate; anything short of this will push the unemployment rate up. As the Fed's calculations show, it is quite likely that trend employment growth will fall well short of this and will continue to decline over the remaining years of this decade due to slower population growth and a decrease in the labour force participation rate. Unfortunately for Americans, these estimates suggest that employment growth levels will be lower than in the past, negatively impacting the speed at which the economy can grow over the coming years and meaning that more Americans are likely to be unemployed for longer periods of time than in past "recoveries".