Friday, December 5, 2014

Hysteresis in unemployment

The scatterplot of unemployment with insured unemployment gives visual evidence of the persistence of unemployment and the long term damage done by labor disruptions.  Here is the plot since 1971, first in raw monthly numbers, then in trailing 12 month moving averages.

We can see that unemployment remains elevated after each event.  Unemployment was relatively low during the 1975 disruption.  But, the recovery only lasted 5 years.  When the next disruption hit in 1980, unemployment was still elevated.  Then, the labor market was disrupted again in 1982, and unemployment, relative to insured unemployment, rose far from the normal range.  The labor market stalled in 1985-1986, but a full-scale disruption was avoided, so relative unemployment continued to slowly decline over time.

The next disruption happened in 1992, after a full 10 years of recovery, so the relative level of unemployment had fallen back into the normal range, but was still high.  The following recovery was 11 years long, so that by 2003, the level of unemployment, relative to insured unemployment, had fallen to below the level of the early 1970's.

Normal UE = total UE predicted by short term UE
Then, I think we see two things going on in the disruption of 2009.  First, since the recovery was only 6 years long, relative unemployment hadn't fallen back to its 2003 level, so the level of unemployment was slightly higher than the trajectory it followed in 2003.  Second, pro-cyclical policies - mainly very long-term unemployment insurance - led to an unusual number of reported very long-term unemployed persons.  We can see this in the third graph, where the level of total unemployment is reliably predicted by short term unemployment until the recent disruption.

At this point, the excess unemployment, relative to insured unemployment, is roughly divided in half.  Half of it could be related to the shortened business cycle that has led to a persistent increase in uninsured unemployment, similar to the 1980s, which appears to slowly decline as the business cycle lengthens.  The other half appears to be related to the unique feature of very long-term unemployment, regarding which there is no American precedent with which to anchor our expectations.

Given these factors, and given that exit rates from short and medium term unemployment should now be unaffected by EUI policies, monthly employment reports will have somewhat less importance, going forward.  Regular unemployment is roughly 5.0% now, and should slowly decline to 4.0% or even less if we can manage to maintain the recovery for another, say, 5 years.  The other approx. 0.8% of reported unemployment is very long term, and presumably marginally attached to the labor force.  While it's decline has been fairly linear for 2 to 3 years, at a rate that would burn it off by early 2016, its further decline and the destination of the workers who are leaving the category, may be difficult to track and may be only tangentially related to other factors at work in the economy.

I may focus less on monthly employment as a result.

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