Between 1950 and 1990--back in the old days of Federal Reserve inflation-fighting recessions--the unemployment rate in the United States would on average close 32.4% of the gap between its initial value and its natural rate over the course of a year. If the United States unemployment rate had started to follow such a path after its fall 2009 peak, we would now have an unemployment rate of 8.3% instead of 8.9%.
But there is the unfortunate fact that none of the United States net reduction in the unemployment rate over the past year comes from increases in the employment-to-population ratio, and all of it comes from decreases in labor force participation. Perhaps we should not be pleased that the United States unemployment rate has fallen from 10.1% to 8.9% over the course of the past year and a half while the employment-to-population ratio has remained stuck at 58.4%. Perhaps we would rather have people who could and who at full employment would have jobs in the labor force, unemployed, and actively looking for work rather than out of the labor force completely.
If we take that view, we note that between 1950 and 1990--back in the old days of Federal Reserve inflation-fighting recessions--the employment to population rate in the United States would on average rise an extra 0.227 in a year for each year that the unemployment rate was above its natural rate. If the United States employment-to-population ratio had started to follow such a path after its fall 2009 peak, we would now have an employment-to-population ratio of 59.7% instead of 58.4%. It would indeed be morning in America, instead of the current economic state.
This is, I think, the best metric to use to quantify the decidedly sub-par pace of the jobless recovery in the United States. It is not out of line with other American yardsticks: since the output trough real GDP has grown at an average rate of 2.86%/year, barely above the rate of growth of the productive potential of the U.S. economy. It is not out of line with the experience of other rich economies, whether in Europe or Japan. It is in sharp contrast, in fact, only to the experience of developing Asia, where the rate of real GDP growth and of unemployment rate decline shows a solid, well-entrenched, and rapid recovery and where inflation will soon become a more significant macroeconomic problem than unemployment.
The obvious hypothesis for why this current recovery--and the last two recoveries--in the United States have proceeded at a sub-par pace is that the speed of recovery is linked to the causes of the downturn. A pre-1990 recession was triggered by a Federal Reserve decision that it was time to switch policy from business-as-usual to inflation-fighting. The Federal Reserve would then cause a liquidity squeeze and so distort the constellation of asset prices to make much construction, sizable amounts of other investment, and some consumption goods unaffordable to demand and hence unprofitable to produce. The resulting excess supply of goods, services, and labor would lead inflation to fall.
After the Federal Reserve had achieved its inflation-fighting goal, however, it would end the liquidity squeeze. Asset prices and incomes would return to normal. And all the lines of business that had been profitable before the downturn would be profitable once again. From an entrepreneurial standpoint, therefore, the problems of recovery were straightforward: simply pick up where you left off and do what you had used to do.
After the most recent downturn, however--and to a lesser extent after its two predecessors--things have been different. The downturn was not caused by a liquidity squeeze. The Federal Reserve cannot wave is wand and return asset prices to their pre-downturn configuration. The entrepreneurial problems of recovery are much more complex: not to recall what it used to be profitable to produce but rather to figure out what new things it will be profitable to produce in the future.
As Dan Kuehn likes to say, a recession is like somebody knocking your jigsaw puzzle, disturbing the pieces and turning some of them over. When the Federal Reserve ends a liquidity squeeze it turns the pieces right-side-up--and so it is easy to reassemble the puzzle. But right now there is nobody to turn the pieces right-side-up--and so things are much harder.
Pursuing this analogy further, I claim that things are even worse. As long as aggregate demand remains low, we cannot even tell when pieces are right-side-up. New investments, lines of business, and worker-firm matches that would be highly productive and profitable if capacity utilization and unemployment were at their normal levels are unprofitable now. We do need not just demand recovery but structural adjustment. But the market cannot do demand recovery rapidly by itself. And it cannot do structural adjustment at all until demand recovery is well under way.