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The Rise and Fall of Labor Force Participation in the U.S.

Tuesday, April 15, 2014

Labor market performance is at the heart of the debate over how to characterize the state of the U.S. economy, wrote Federal Reserve Bank of St. Louis President James Bullard in The Regional Economist.  The unemployment rate has generally declined faster than many forecasters anticipated since it hit 10 percent in the fall of 2009, he noted.  Along with this development, labor force participation (LFP) has declined substantially, as shown below.

There are two main interpretations of these data, Bullard said.  According to the “bad omen” view, the recent declines in LFP are suggestive of a very weak labor market; this view discounts the signal coming from recent faster-than-expected declines in unemployment.  According to the “demographics” view, recent declines in LFP are more benign; this view takes the signal coming from recent faster-than-expected declines in unemployment at face value.  “Since the Federal Open Market Committee has explicitly tied monetary policy choices to labor market performance, it is of considerable importance which view is more nearly correct,” Bullard pointed out.

It is helpful to review the LFP data over several decades, which are shown in this chart:

The rise in LFP during the 1970s, 1980s and 1990s is often attributed in part to the maturing of the baby boomers, as well as to the increase in the number of women in the workforce.  The decline since 2000 has often been attributed to the aging of the labor force.

Bullard’s view, based on some of the available literature, is that carefully constructed empirical models of the trend in the U.S. LFP rate do a good job of explaining the data.  In such models, certain demographic groups have a certain propensity to participate in the labor market.  He said that these demographically based models suggest the current participation rate is not far from the predicted trend, which means, in turn, that the cyclical component in LFP is likely to be relatively small.

“To the extent these models are correct, then, the observed unemployment rate remains as good an indicator of overall labor market health as it has been historically.  In particular, the recent, relatively rapid declines in unemployment can be understood as representing an improving labor market.  This is the judgment that should inform monetary policy going forward,” wrote Bullard.

However, he noted that the literature is not completely satisfactory.  Including more detailed household decision-making in economic models would allow for a better understanding of what motivates or deters participation in labor markets, Bullard said.

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