Don’t Worry if Unemployment Seems to Get Stuck in 2013

Last week, we put out a 2013 economic outlook. Our take on the U.S. economy is fairly positive…if the U.S. government can avoid the nastiest parts of the fiscal cliff. So let’s say that Republicans and Democrats can come to a solution, and the United States manages to avoid recession in the first half of the year. As the U.S. economy keeps improving in 2013, the unemployment rate should keep dropping, right? It’s dropped from 8.8% last November to its current level of 7.8% in about 12 months.

Well, as we get into 2013, don’t be too worried if that pace seems to stall for a while…at least, don’t worry that the recovery has stalled. A paper from the San Francisco Fed looked at exactly this issue earlier this week. The Bureau of Labor Statistics measures labor force participation. This is the percentage of “non-institutional working-age population 16 and older that is working or actively looking for work.” By this measure, if you found yourself unemployed and decided to go back to school full time or be a stay-at-home dad, then you’ll fall out of the official unemployment counts.  Labor force participation has dipped quite a bit since the recession, but as the economy continues to improve, those potential workers who gave up looking for a job may get back out there and re-enter the job market.

As the San Fran Fed points out, it’s reasonable that these re-entrants could be enough to temper the decline in the unemployment rate. We anticipate stronger job growth in 2013. With an improving housing market, the labor-intensive construction sector will likely add jobs. Productivity growth has been pushed to the limit, and businesses will have to increase the pace of hiring just to keep up with even a modest rise in sales volumes. But will that pace be enough to pick up not only the currently unemployed, but also all of those 15-year-olds who will turn 16 and enter the work force this year, AND the potential re-entrants into the job market? We think it will, but of course, that’s not for sure.

Speaking of the Fed…there’s an implication for this idea with current monetary policy goals. With the announcement that that the Fed would be tying their monetary policy to explicit unemployment and inflation targets, any stagnation in the declining unemployment rate could be costly for the Fed’s balance sheet. The economy could be improving and adding jobs at its current clip, but if re-entrants are offsetting the growth in payrolls to keep the unemployment rate steady, the Fed would be anchored to an already lagging indicator that now is masking the true speed of the recovery. You can read more on my thoughts from earlier this week about Fed targets here.