Shrinking Workforce Will Have Long-Term Impact

By FOXBusiness

The disturbing trend that has seen U.S. unemployment fall to its lowest level in five years not because more jobs are being created but because a smaller percentage of Americans is working could force the Federal Reserve to rethink its plans for winding down its easy-money policies.

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Specifically, if the headline unemployment rate and the labor force participation rate continue to follow the same downward trajectories analysts say the Fed’s timetable for raising interest rates might have to be pushed back, a move that could increase the threat of inflation.

Fed Chairman Ben Bernanke has said the central bank will wait until unemployment hits a threshold of 6.5% before the Fed will consider raising interest rates. But that threshold might have to be lowered if unemployment is falling for the wrong reasons.

Unemployment fell to 7.3% in August, down slightly from 7.4% a month earlier, according to data released last week by the U.S. Department of Labor. The rate has fallen from a financial crisis high of 10% in October 2009.

This would all be good news except the August decline, like many of the rate declines since the recession ended over four years ago, was caused by another big reduction in the workforce as more and more discouraged Americans give up trying to find a job. The Labor Department said 312,000 people dropped out of the labor force between July and August.

Leaving The Workforce In Droves

“Is 7.3% accurate? No, it’s not accurate.”

Bob Funk, former Kansas City Fed president

With Americans leaving the workforce in droves, the labor force participation rate, which measures the number of people who are actually working and/or actively seeking a job against the broader population, has fallen to its lowest level in 35 years.

Both of these key economic data points have been on downward trajectories since the economic recovery began in 2009. And the trend has recently accelerated. During the past three months, the U.S. economy added an average of 148,000 jobs per month, well below the 12-month average of 184,000, according to the Labor Department.

Yet even as fewer jobs are created and more people are leaving the workforce the unemployment rate continues to fall.

So what happens if this long-term trend holds and the unemployment rate eventually falls to 6.5% -- the interest-rate threshold set by the Fed -- even as the labor force participation rate also continues to decline?

Neil Dutta, head of U.S. economics at Renaissance Macro Research in New York, said if the unemployment rate continues to fall because the workforce is shrinking rather than because more Americans are finding jobs the Fed will probably lower its unemployment/interest rate threshold to 6%.

“That’s certainly possible,” Dutta said.  “There’s a decent chance that could happen next year.”

Delaying an increase in interest rates raises the threat of inflation as low rates ostensibly spur borrowing, pushing more cash into the system and raising the prices of goods and services. That hasn’t happened yet (in fact the opposite has occurred) but the Fed remains wary.

Difficult Task Now Facing the Fed

Dutta said the Fed won’t be relying solely on the unemployment rate to determine when to start raising interest rates. But if the rate hits that 6.5% threshold primarily because of a contracting workforce the Fed will likely wait a few months to see if that level holds and then lower the threshold accordingly.

The Fed slashed interest rates to near zero and has held them there since December 2008 during the worst of the financial crisis. Since then the Fed also approved three rounds of massive bond purchases known as quantitative easing, expanding their balance sheet to an unprecedented $3.6 trillion in assets.

The difficult task now facing the Fed is figuring out how to wind down these easy-money programs while balancing the threat of inflation if they remain in place too long against the threat of disrupting the already-fragile recovery if the programs are ended too soon.

Economists cite two primary reasons for the shrinking workforce: large numbers of retiring boomers and droves of twenty-somethings -- so-called millennials -- who have given up looking for work in the difficult post-financial crisis landscape.

These two conditions are at the center of an ongoing argument over whether the issues facing the struggling U.S. labor markets are ‘structural’ or ‘cyclical.’ If the labor force participation rate is being pulled down by a generation of workers leaving the workforce because of their age then it’s a structural issue. If the problem is discouraged young workers who will return to the workforce when conditions improve then the situation is cyclical.

Fed policy makers are apparently split over structural versus cyclical.

“Government Intrusion” Is Taking Its Toll

Bob Funk, CEO of Express Employment Professionals, an Oklahoma City-based staffing service, and a former president of the Kansas City Fed, believes the problems are structural.

Baby boomers who either want or need to go back to work often can’t because they lack the skills required in a shifting employment landscape that now leans toward high-tech, said Funk. At the same time, generous social welfare benefits in many states for the unemployed and disabled are acting as a disincentive for many millennials to return to the workforce.

“Government intrusion” is also taking its toll on hiring, according to Funk. A raft of new regulations – especially in the area of accounting – crafted in the wake of the financial crisis has raised costs for all businesses, and uncertainty about new health care laws set to take effect in 2014 have made employers skittish about taking on new workers.

“We don’t know what our costs are going to be so we have to be very cautious,” Funk said.

Funk said the unemployment rate would likely be closer to 9.3% if the Labor Department took a different approach toward counting those who are eligible to work but aren’t currently employed.

“Is 7.3% accurate?” he said. “No, it’s not accurate.”

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