By
Matthew Philips on December 27, 2012 - Businessweek
As long as inflation remains in check, the Federal Reserve has
promised not to raise interest rates until unemployment hits 6.5 percent. So
how long until that happens? A few estimates are worth noting for the
contradictions they reveal in the labor market.
According to calculations
by the Brookings Institutionfs Hamilton Project, at the current pace of job
growth, about 155,000 jobs per month over the past two years, we wonft see 6.5
percent unemployment until 2018. That would mean a decade of zero percent
interest rates. It has been four years since the Fed lowered rates to near zero.
Imagine another six.
But donft worry. Most economists think wefll hit 6.5 percent way sooner than
2018. The average prediction of 75 economists surveyed by Bloomberg is that
unemployment will be down to 7.3 percent by the second quarter of 2014. Both Joe
Lavorgna, chief economist at Deutsche Bank, and Jacob Oubina, senior economist
at RBC Capital Markets, think wefll be at 6.5 percent by then. Thatfs not
because they feel better about the economy. Itfs actually because theyfre more
pessimistic about it.
The researchers at the Hamilton Project based their projections off the
Congressional Budget Officefs 2011 estimates (PDF)
of labor force participation over the next decade. The CBO assumes that for
the next 10 years, the size of the work force will grow at the same pace it did
over the previous decade, 0.8 percent a year. Right now, the labor force is
expanding at less than half that pace. As people give up looking for a job, the
labor force is growing much slower than anticipated.
The smaller the labor force, the fewer jobs you need to push down the
unemployment rate. This is the dark cloud behind the steady decline in the
jobless rate wefve seen over the last year. Much of the drop has been due
to people fading from the labor force, rather than robust job gains. If you
factor in the 2.5
million people who want a job but have stopped looking, and therefore arenft
counted as unemployed, the jobless rate jumps to 14.4 percent.
This the trouble with tying monetary policy to the unemployment rate: Itfs
murky as a signal for the health of the economy. James K. Galbraith, an
economist at the University of Texas, thinks that continued shrinkage of the
labor force will lower the rate faster than a strong economy that encourages
people to start looking again. gA stronger economy might actually hold it up
longer,h says Galbraith.
And thatfs the irony of the current labor market. The slow pace of job growth
has actually hastened the decline in the unemployment rate. Once the economy
starts adding more jobs and people are compelled to restart their job search,
the unemployment rate may stagnate, if not rise. This is what Jan Hatzius, chief
economist at Goldman Sachs, thinks is going to happen in 2013. gIfm surprised at
how quickly the participation rate declined this year,h says Hatzius. gOur
models say it should stabilize, if not rise, next year.h Which is why he
foresees a slowdown in the decline in the unemployment rate through 2013. Not
because the economy will be worse off, but because it will be
better.