Falling labour participation in the US: causes and effects

The current recovery has been different in the United States. Though unemployment has fallen from 10% to 6.1%, labour-force participation has not increased. In fact, it has declined to its lowest level since 1978. This is controversial. Some economists say long-term structural factors, mainly aging, explain most of the recent drop in the labour force. Others argue that short-term, cyclical factors are mostly to blame: workers are sitting out the job hunt, waiting for better opportunities.What about the effects?

Check out this interesting animated graphic in the Economist.

The effect of these changes is probably of greatest interest to the US Federal Reserve's monetary policy decision makers. If the decline in labour-force participation is mostly structural, then the unemployment rate is a reasonable measure of the remaining slack in the labour market, and the Fed will have to move relatively soon to raise interest rates to prevent the economy from overheating. There is little spare capacity in the economy.

But if the low level of participation is temporary and cyclical, then there is more spare capacity than the unemployment rate suggests, and the Fed can take its time about tightening monetary policy.

You might recognise this problem if you’ve ever wondered about the size of the output gap. There’s a great deal of uncertainty about the amount of spare capacity there is in the economy at any one time.

For now, though, the post-crisis economy looks unique: there are more people back at work—and more people out of work too.