Mary Daly, Vice President of the San Francisco Fed, gives her view of the economy with a focus on labor force participation. Based upon her analysis of participation rates, she believes the unemployment rate accurately reflects conditions in the labor market:
FedViews, by Mary Daly: Mary Daly, Vice President at the Federal Reserve Bank of San Francisco, states her views on the current economy and the outlook:
- According to advance estimates, GDP growth rose sharply in the first quarter—increasing by 4.8 percent—as the economy rebounded from the direct and indirect effects of last year’s hurricanes. We expect GDP growth to downshift to a more sustainable pace over the course of this year, slowed by the lagged effects of higher interest rates, elevated energy and commodity prices, and a cooling housing market.
- Incoming data on prices have left core inflation at the top of the range seen over the past several years, nearing the top of the so-called comfort zone of between 1 and 2 percent. Looking forward, tightening labor and goods markets and lagged effects of elevated energy and commodity prices point to a potential uptick in inflation in coming quarters. On the other hand, labor costs remain relatively subdued and underlying productivity growth remains strong, which should help contain inflationary pressure. Altogether, we expect core PCE inflation to be about 2 percent this year.
- On May 10 the FOMC raised the fed funds rate 25 basis points to 5 percent. Market participants fully anticipated the increase. Looking forward, markets expect further tightening in 2006, but are uncertain about the timing. This is consistent with the FOMCs focus on incoming data and its effects on the outlook.
- After hitting a historical peak in 2000, labor force participation—defined as the fraction of the civilian, non-institutionalized population age 16 and over working or actively looking for work—dropped precipitously, reacting in part to the downturn in the economy.
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- The extent to which the decline reflected cyclical or secular pressures has been a topic of much debate. The answer directly affects measures of labor market slack, such as the unemployment rate, but also affects longer-term issues like the speed at which the economy can grow (potential output growth), and forecasts of government budgets including Social Security.
- A key determinant of the aggregate participation rate in an economy is the age distribution of the population. Labor force participation rates are highest for those aged 25-54; after age 55, labor force participation rates fall continuously as individuals retire. Thus, the aggregate U.S. labor force participation rate is expected to fall as the baby boom generation ages and retires.
- The second key determinant of aggregate participation rates is the behavior of various demographic subgroups over time. Researchers typically follow four key subgroups: men 25-54; women 25-54; youth 16-24; men and women 55+. Labor force participation for these groups has changed over time.
- Participation rates of men 25-54 have been gradually falling for more than 40 years. Labor force participation rates for women 25-54 have leveled off after a long period of growth, suggesting that this shift may have played out. Participation rates for youth have been coming down, albeit in fits and starts, for over a decade and data on school-work choices suggest that young people are focusing on education. In contrast to the other three subgroups, labor force participation rates for individuals aged 55 and over have increased in recent years.
- Netting the effects of the aging baby boomers and the behavioral changes of the key demographic subgroups, we expect trend labor force participation to gradually decline over the forecast horizon.
- Given this forecast, current values of labor force participation are right on trend, suggesting that the unemployment rate is a reasonable measure of labor market slack.
- Looking forward, the decline in labor force participation over time will slow growth in the labor force and restrain growth in potential output in the economy.