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Central Banker | Winter 2011

In-Depth

What’s Not Working This Time Around? Third Dialogue Examines Why Unemployment Remains High

The nation lost more than 9 million jobs during the Great Recession, and the unemployment rate has been stuck around 9 percent for more than two years. Companies, uncertain about the recovery, remain reluctant to hire, and millions of job seekers have stopped looking for work entirely.

Because the employment situation has been so frustrating and confusing, the St. Louis Fed hosted “Understanding the Unemployment Picture” on Nov. 21 to offer insight on this issue and answer attendees’ questions. As part of the “Dialogue with the Fed” series, Christopher Waller, senior vice president and director of Research, led the presentation and discussion, with assistance from economists David Andolfatto and Natalia Kolesnikova.

The Causes Are Many

Most recessions between World War II and the Great Recession had several things in common. For example, after a sharp spike in unemployment, housing starts and sales would lead the recovery and unemployment would decline in response to monetary or fiscal policies. That pattern did not occur this time around.

Unemployment doubled between January 2008 and October 2009, and more than two years after its peak of 10.2 percent, the unemployment rate has fallen only about 1.1 percentage points. “In 2008-2009, we lost 750,000 jobs for six straight months. That’s why it’s called the Great Recession,” Waller said. “These numbers are staggering, and it means we’ve dug a very big unemployment hole.”

Several interrelated factors are contributing to high unemployment:

Housing isn’t leading the recovery. The collapse of the housing market was one of the primary drivers of the financial crisis and Great Recession. After effectively building 12 years’ worth of houses in five years, this sector alone lost nearly 2 million jobs, with peripheral industries losing another 800,000. “What we’re seeing is a big recession heavily dominated by one sector,” Waller said.

Monetary and fiscal policies don’t seem to be helping employment. Since the start of the financial crisis, the Fed has lowered its key interest rate to effectively zero and the federal government has lowered tax rates and spent upwards of $1 trillion to stimulate the economy. “But we haven’t seen in the data any kind of dramatic rebound in investments or buying of durable goods and housing,” Waller said. “There is some spending, some hiring, some housing buys, but there seems to be a permanent drop in the level of consumption relative to the previous trend.”

Households are retrenching. Consumption is lower partly because people have been deleveraging— restraining spending, reducing debt and repairing their balance sheets—over the past couple of years. “So, people are trying to get their debt down while we’re encouraging them to spend—and it’s not working like it has in the past,” Waller noted.

Uncertainty weighs on most businesses. While some sectors, such as health care, continue to do well, overall hiring appears stuck. “We’ve asked businesses point-blank why they aren’t hiring, even with very low interest rates and tax rates. They point to the lack of customers and the large uncertainty surrounding the health care laws, regulations and the political situation,” Waller said.

The Labor Market Seems To Be Changing

Many businesses now treat layoffs as permanent job cuts instead of temporary decisions to be reversed when the economy improves. And while many businesses are posting vacancies, they aren’t necessarily filling them.

Under normal economic conditions, vacancies are high when unemployment is low and vice versa. However, even though vacancies are coming back to pre-financial-crisis levels, unemployment remains high. This leads some economists to believe that some structural changes are happening in the labor market. (Please see “Many Moving Parts: A Look Inside the U.S. Labor Market” for details.)

As seen in the Figure at left, 42 percent of the unemployed have been out of work for at least six months, more than twice the percentage observed before the start of the financial crisis. “One study suggests that about half of the increase in long-term unemployment can be explained by demographic changes before the recession started, especially among older people,” economist Kolesnikova said.

“Although unemployment rates are higher for younger workers, the rate is larger for all workers. Even people with college degrees—regardless of their age—are
unemployed at a higher rate now,” she said.

Kolesnikova also noted that the market has become polarized between low-skill, low-pay jobs and high-skill, high-pay jobs; middle-skill, middle-pay jobs are disappearing. “For the past three decades, workers at midlevels have been replaced by computers, automation or jobs being sent overseas—a trend that has accelerated during this recession,” she said.

Unemployment Duration

Unemployment spells are much longer for many

Figure: Unemployment Duration

Note: Due to rounding, numbers do not equal 100 percent.

Source: Bureau of Labor Statistics

Can the Fed Bring Down Unemployment?

In a survey from a previous “Dialogue with the Fed,” 62 percent of audience members responded that the Fed could do little or nothing to bring the rate down. Waller agreed. “The Fed doesn’t have much direct control over unemployment. We can use interest rates to help firms and help stimulate demand, but at the end of the day, we don’t create any jobs; the private sector does. If they say no to our efforts, there is not much we can do about it,” Waller said.

Even though the economy is flush with liquidity and the Fed has lowered the federal funds rate as far as it can go, some have called for more policy easing by suggesting the Fed aim for a specific unemployment rate. But that approach concerns policymakers and economists, including Waller, who are wary that the U.S. could enter a long period of high unemployment akin to what occurred in Europe during the 1980s and 1990s.

“We don’t want to tie monetary policy to a specific unemployment number because we could end up stuck in that mode for decades,” Waller explained.

In Sum: No Easy Solution To Ending High Unemployment

The Great Recession and its aftermath have not followed the historical patterns for recessions and recoveries: Unemployment has stayed around 9 percent for more than two years, the number of people out of work for more than six months is more than double pre-financial-crisis levels, and housing appears unable to lead the recovery. Economists are also seeing persistent changes in the labor market.

Although private payroll job growth stayed positive in 2010 and 2011, the growth appears inadequate to lower the high unemployment rate. Policymakers, lawmakers and economists have been debating the effectiveness of current monetary and fiscal policies designed to encourage spending and drive down unemployment.

>> MORE ONLINE

Construction and the Great Recession
www.stlouisfed.org/construction

Why Is Employment Growth So Low?
www.stlouisfed.org/lowgrowth

 

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