Why is the Unemployment Rate Falling so Fast?
Why is the unemployment rate falling so fast? What kind of stupid question is that? Sure, the 7.4 percent unemployment rate in July is down from 10 percent in October 2009. But 7.4 percent is higher than any unemployment rate during or after the 2001 recession, and it's near the peak unemployment rate after the 1990-91 recession (7.8 percent in June 1992).
Down to 7.4 percent in July 2013. You call that fast?
OK, the unemployment rate is falling fast, considering how slowly the economy is growing. Let's look at the yearly growth rates for inflation-adjusted gross domestic product - that's "real growth" - from 1963-2013. We'll use the half-year numbers for 2013, just so we can include this year. Real growth averaged 3.1 percent per year during those 50 years.
There were 14 years when real growth was slower than 2.5 percent. In 12 of those years the unemployment rate went up. The exceptions are 2011 and 2013. In both of those years, the economy grew slowly, but the unemployment rate still went down. Since 1963, there have been 22 years when real growth was less than 3 percent. In 16 of those years, the unemployment rate went up. Three of the six exceptional years are 2011, 2012 and 2013.
Real growth from 2010-11 was 1.8 percent. The unemployment rate dropped from 9.6 percent to 8.9 percent. In 2012, real growth was 2.8 percent, and the unemployment rate dropped to 8.1 percent. Real growth so far in 2013 is 1.4 percent, and the unemployment rate has dropped again, to 7.4 percent.
With the economy growing as slowly as it has, the unemployment rate should be going up. Instead it's going down. Why?
Let's back up the question. Why does the economy have to grow at all to keep the unemployment rate from rising? Why do we have to run to stay in the same place? It's because the labor force keeps growing. Kids turn 16 and become eligible to work. Young people graduate from high school and college and start looking for jobs. The economy has to grow to create jobs for these new workers or they'll be unemployed, and the unemployment rate will rise.
From 1963-2011, the labor force grew an average of 1.6 percent per year. From 2011 to mid-2013, it's grown 0.7 percent per year. Labor force growth has slowed down. So, we don't have to create as many jobs to bring the unemployment rate down. An economy growing at 1.4 percent creates enough jobs to employ those few new workers, and more.
So why is the labor force growing slowly? Part of the reason must be the severity of the Great Recession. The Bureau of Labor Statistics measures "discouraged workers," who searched for work without success for so long that they gave up. If they're not working and not searching, they're not counted as part of the labor force.
As the economy recovers, discouraged workers usually start looking again, and the number of discouraged workers declines. But in January 2011, the BLS estimated there were 993,000 discouraged workers, and in July 2013 there were still 988,000. The recession was so bad - and the recovery so slow - that hundreds of thousands of people who would ordinarily be looking for work are still waiting. That makes the unemployment rate fall faster.
The Great Recession was so severe that the labor force actually decreased for a while. From August 2009-August 2011, it decreased in most months. The last time the labor force decreased was July 1962. Before then, labor force decreases during or after recessions were pretty common.
Consider 1962. The original 1946 baby boomers turned 16. The labor force grew fast through the early 1980s as the boomers came of age. Now, though, the first baby boomers are starting to retire. It may be that labor force growth will be slower from now on.
These days, it probably takes real growth above 1-1.5 percent to bring the unemployment rate down, not 2.5-3 percent. We should expect continued decreases in the unemployment rate this year and next, even with our lukewarm recovery. Down is still better than up, but the falling unemployment rate isn't really the good news it once was.