Louis ( ), NBER-based Recession Indicators for the United States from the Period following the Peak through the Trough, retrieved from FRED, Federal Reserve Bank of St. Sources: US Bureau of Labor Statistics, Unemployment Rate, retrieved from FRED, Federal Reserve Bank of St. Note: Gray bars indicate recession periods. This view of the alignment (panel D) highlights the intuition that frequent recessions, separated by short expansions, are associated with upward drift in the unemployment rate, while infrequent recessions, separated by long expansions, are associated with downward drift. Recessions and Unemployment Rate Trendsįigure 2 depicts a series of computations that result in a view of the alignment between recessions and the unemployment rate. I intend for this hypothetical scenario to match the spirit of the FOMC’s longer-run projections of the unemployment rate, which are made “in the absence of further shocks to the economy.” 9 My forecasts project that the unemployment rate will go to 3.6 percent after a long period with no recessions. I use the VAR to make forecasts of the unemployment rate under the hypothetical scenario that there will be no recessions in the future. I also estimate the relationship between recessions and the unemployment rate with a statistical model called a vector autoregression (VAR). 8 In February 2020, the unemployment rate fell to 3.5 percent, its lowest level since 1969. Since 1983, recessions have been less frequent and expansions have been longer, causing the unemployment rate to regularly fall below its previous low point and generating a downward trend in the unemployment rate. Figure 1 shows that this happened in the 1950s and the 1970s. 7 Hence, frequent recessions can cause the unemployment rate to trend up over time. Because the unemployment rate rises quickly in recessions but falls slowly in expansions, it may not fall to its previous low point if a recession cuts an expansion short. 6 In this Commentary, I suggest an additional, previously unrecognized source of the trend: the frequency of recessions. Research has attributed much of the trend in the unemployment rate to demographic changes. 3 Policymakers on the Federal Reserve’s Federal Open Market Committee (FOMC) note in their Statement on Longer-Run Goals and Monetary Policy Strategy that the maximum level of employment “changes over time.” 4 In fact, the longer-run projections of the unemployment rate in the FOMC’s Summary of Economic Projections have drifted down since 2012. Researchers typically remove a time-varying trend from the unemployment rate before studying its business cycle properties. Researchers and policymakers often acknowledge the trend in the unemployment rate. Notes: Trend computed using a Hodrick and Prescott (1997) filter. Because of this changing trend, an unemployment rate of 6 percent may be viewed as indicating macroeconomic slack in some periods but macroeconomic health in other periods, making it difficult for economists, policymakers, and the public at large to know where the economy stands. 1 The trend line shows substantial variation, falling below 5 percent in the 1960s and 1990s and rising above 7 percent in the 1980s and 2010s. I compute this line with the statistical technique in Hodrick and Prescott (1997) (HP). It shows the monthly unemployment rate from January 1948 to October 2020 along with a line intended to estimate the unemployment rate trend. If the trend is not static, then it is hard to know how far the current or forecasted unemployment rates are from the underlying trend. One issue that can confound this simple interpretation is that the unemployment rate may have a slow-moving trend that changes over time. A high or rising unemployment rate is a signal of macroeconomic slack or contraction, and a low or falling unemployment rate is a signal of macroeconomic health or expansion. An appealing feature of the unemployment rate is its perceived ease of interpretation. It receives attention from academics, policymakers, business economists, and politicians, but also the public at large. When it comes to analyzing economic indicators to predict where the US economy is headed, the unemployment rate is arguably the variable familiar to most people.
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