The unemployment rate has been falling sharply alongside a sizable drop in labor force participation.
The labor force participation rate is the ratio of Americans counted in the labor force to the total civilian noninstitutional adult population, while the unemployment rate is the ratio of those without a job who are counted in the labor force (i.e., unemployed and searching for work) to the total labor force.
Because the labor force is expanding at a slower rate than the population, the participation rate is going down. And because the ranks of the unemployed are falling as the labor force expands, the unemployment rate is going down.
One of the overarching concerns in this recovery has been the large wave of unemployed workers who, in the wake of the recession, were unable to find a job for an extended period of time, became discouraged, and gave up looking for work. This caused them to cease being counted as (a) in the labor force and (b) among the ranks of the unemployed, thereby causing both the participation rate and the unemployment rate to drop.
Most of the drop in the labor force participation rate can be attributed to demographics — workers from the "baby boomer" generation are retiring, and disability is rising as the population ages).
However, the surge in discouraged workers outside the labor force — from a nadir of 4.4 million in October 2007 to peak levels just under 7.0 million in August 2012 (Chart 1) — has had a substantial impact on how the employment figures are calculated.
In December, the unemployment rate was 6.7% and the labor force participation rate was 62.8%.
Where would the two figures be if all of the discouraged workers that left the labor force since October 2007 came back, and were officially counted as unemployed?
Chart 2 shows that the participation rate would be a 0.7 percentage points higher, at 63.5%.
Chart 3 shows that the unemployment rate, meanwhile, would be a full percentage point higher, at 7.7%.
Could unemployment rise going forward if a wave of previously discouraged workers re-enters the labor force?
Drew Matus, deputy chief U.S. economist at UBS, thinks this is unlikely.
"Although we believe that there could be a modest cyclical rise in participation as the economy improves, we believe the likely scale of the increase will not significantly alter the basic equation: payroll growth averaging 200,000 per month should continue to pull down the unemployment rate under all but the most aggressive labor force expansion estimates," says Matus.
"As a consequence, the unemployment rate should continue to decline and there is downside risk to our year-end 2014 forecast unemployment rate of 6.4%."
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