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Blogs review: The employment to population ratio

What’s at stake: The drop and lack of recovery in the employment to population (E/P) ratio has raised questions as to whether the drop in the unemployment rate represents a genuine improvement in the US labor market. A recent study by the NY Fed, which argued that the demographically adjusted E/P ratio was just 0.7 points below trend, has received considerable attention in the blogosphere and among Fed watchers as it corroborates the picture of a recovering labor market.

By: Date: February 17, 2014 Topic: Global Economics & Governance

What’s at stake: The drop and lack of recovery in the employment to population (E/P) ratio has raised questions as to whether the drop in the unemployment rate represents a genuine improvement in the US labor market. A recent study by the NY Fed, which argued that the demographically adjusted E/P ratio was just 0.7 points below trend, has received considerable attention in the blogosphere and among Fed watchers as it corroborates the picture of a recovering labor market.

Assessing the health of the US labor market

Matthew Klein writes that in an effort to take into account the fact that many people stopped looking for work right about the time the economy tanked and have kept dropping out of the labor force throughout the gradual economic recovery, analysts have used other measures than the unemployment rate to gauge the health of the labor market.

Sober Look writes that measures such as the employment-population ratio have completely diverged from the "headline" unemployment rate. Real Time Economics reports that the employment-to-population ratio, which measures the proportion of the adult population with jobs, has dropped 4.1 percentage points from its average since the start of the 2008-2009 recession, and has stayed pretty steady since. The drop and lack of recovery has led to questions about whether the labor market is doing as well as the current 6.7% unemployment rate suggests. 

Source: Sober Look

Thomas Klitgaard and Richard Peck write that roughly half of the difference in the unemployment rates between the US and the euro area is due to divergent trends in labor force participation over the last three years. The drop in labor force participation in the US has accentuated the fall in the U.S. unemployment rate and widened the gap between the unemployment rates of the US and the euro area. If the euro area had seen a drop in the labor force participation rate proportional to the decline experienced by the United States, its unemployment rate would be about 9.5 percent, below where it was at the beginning of the sovereign debt crisis.

A misleading indicator: demographic factors

Samuel Kapon and Joseph Tracy of the NY Fed write that the E/P ratio is a misleading indicator for the degree of the labor market recovery because it doesn’t take into account demographic changes that would have impacted the ratio independent of the recent recession. The effect of population aging on the E/P ratio depends on the distribution of individuals in the economy across the rising and falling sections of their career employment rate profiles. The authors use 280 estimated career employment rate profiles to create a demographically adjusted E/P ratio.

Source: NY Fed

Samuel Kapon and Joseph Tracy write that the result indicates that although the actual E/P ratio has not changed since the end of the recession, the E/P gap defined as the difference between the two lines is actually closing due to this decline in the demographically adjusted E/P ratio. That is, a relatively constant E/P ratio since the end of the recession represents improvement in the labor market relative to an underlying demographically adjusted E/P ratio that is declining. 

John Robertson of the Atlanta Fed writes that a simple, and admittedly crude, alternative to computing the demographically adjusted employment-to-population ratio trend is to look at a segment of the population that is on a relatively flat part of the employment (or participation) rate curve. A common standard for this is the so-called prime-aged population (people aged 25 to 54). These individuals are less likely to be making retirement decisions than older individuals and are less likely to be making schooling decisions than younger people. The prime-aged employment-to-population ratio declined almost 5 percentage points between the end of 2007 and 2009 (versus 4 percentage points overall) and since then has recovered about 25 percent of that decline.

A misleading indicator: baseline factors

Paul Krugman writes that the way the New York Fed researchers present their finding is likely to mislead because it mixes two propositions together. One, which is clearly true, is that the aging of the adult population would have meant a considerable decline

in the employment-population ratio over the past 7 years even if the economy had remained near full employment. The other, which is far from obvious, is that the economy was highly overheated in late 2007, with employment far above sustainable levels.

Samuel Kapon and Joseph Tracy adopt the normalization that over the thirty-one years in our data sample (1982–2013) any business-cycle deviations between the actual and the adjusted E/P ratios will average to zero. With this normalization, the authors argue that the E/P ratio was 1.6 percentage points above the demographically adjusted E/P ratio just prior to the onset of the recession and is now only 0.7 points below trend. Pat Higgins of the Atlanta Fed writes that this methodology seems reasonable since one might typically expect business cycle effects to average out over 30 years. However, the 1982–2013 sample period is somewhat unusual in that the unemployment rate was elevated at both the starting and ending points.

Paul Krugman writes that the dramatic-sounding result that we don’t have much labor market slack is due to their normalization. Just doing the demographic correction reduces the employment gap — but it’s still big unless you accept the idea that the U.S. was a highly overheated economy on the edge of major inflation before the crisis. Pat Higgins writes that If one were to normalize the Kapon and Tracy E/P trend so that its average value was equal to CBO’s trend, then the November 2013 E/P gap is about 1.5 percentage points.


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