by Calculated Risk on 5/13/2013 06:04:00 PM

The participation rate has declined sharply since the recession started due both to cyclical reasons and also because of demographics (baby boomers retiring) and long term trends (more 16 to 24 year olds staying in school is an example). A key question is: How much of the recent decline is due to cyclical factors and how much of the decline was expected due to long term factors?

Note: The table at the bottom from Dr. Altig shows the relationship between the participation rate and the unemployment rate.

My view has been that there is a large long term factor, although I have expected some bounce back in the participation rate as the economy improves.  Others think there are larger cyclical factors, but they only expect a small bounce back too ...

An FSFRB economic letter using state level data: Will Labor Force Participation Bounce Back?

The U.S. labor force participation rate has declined sharply since 2007, intensifying a downward trend that has been evident since about 2000. Distinguishing between long-term influences on the participation rate, such as demographics, and short-term cyclical effects is important because it helps us understand and predict the future path of macroeconomic variables such as the unemployment rate. Using state-level evidence on the relationship between changes in employment and labor force participation across recessions and recoveries, we find evidence, reinforcing other research, that the recent decline in participation likely has a substantial cyclical component. States that saw larger declines in employment generally saw larger declines in participation. A similar positive relationship was evident in past recessions and recoveries. In the current recovery, it will probably take a few years before cyclical components put significant upward pressure on the participation rate because payroll employment is still well below its pre-recession peak.
emphasis added

And from Julie Hotchkiss at the Atlanta Fed: Behavior’s Place in the Labor Force Participation Rate Debate

Casselman, in an October 2012 WSJ article, cites work by my colleagues at the Chicago Fed, who find that while more than two-thirds of the decline in LFPR between 1999 and 2011 is accounted for by changes in the age distribution of the population, "…over the 2008-2011 period...only one-quarter of the...decline of actual LFPR...can be attributed to demographic factors."

This conclusion—that three-quarters of the decline in the LFPR since the beginning of the Great Recession can be attributed to cyclical factors—is supported by other research.
...
Our results suggest that relative to the the average LFPR over the years 2010–12, the average LFPR over the years 2015–17 will rise by about a third of a percentage point—again, if the labor market returns to prerecession conditions. Though higher than today, this level would still leave the LFPR considerably lower than it was before the recession, primarily reflecting the continued downward pressures of aging baby boomers.

And from David Altig at the Atlanta Fed: Labor Force Participation and the Unemployment Threshold

[T]aking the Hotchkiss and Rios-Avila research onboard means the assumption of a constant labor force participation rate may not be justified. So, turning again to the Jobs Calculator, the following table answers this question: If we continue on the 208,000-per-month pace of job creation of the last six months, and the labor force participation rate is X, what would the unemployment rate be by June of next year? For reference, the first row of the table replicates the earlier result under the assumption that the participation rate will maintain its current level; the second row takes into account the Hotchkiss and Rios-Avila research; and the third assumes an even larger bounce back in participation:

Click on graph for larger image.
It is probably worth noting that the full increase in the Hotchkiss and Rios-Avila estimates happens in the 2015–17 timeframe, raising the interesting possibility that the threshold for considering interest rate increases could occur sometime before the unemployment rate moves back above the threshold. Also, it is not at all obvious that rising labor force participation would necessarily arrive along with a rising unemployment rate. From 1996 through 1999, for example, the participation rate rose by nearly by 0.7 percentage point (the difference between the rates in the first and third rows in the table above), even as the unemployment rate fell by just over 1½ percentage points. The key was the strong employment growth over that period—almost 260,000 payroll jobs per month on average.

This table shows the impact of the participation rate. If the participation rate stays flat at 63.3% (the current level), than at the current pace of payroll jobs growth, the unemployment rate will fall to 6.5% by June 2014. However if the participation rate rises to 63.6% - with the same payroll assumptions - the unemployment rate will only decline to 7.0% by next June. A significant difference ...

I think the state level research is compelling, but I don't expect much of an increase in the participation rate over next few years. And I expect further declines in the overall participation rate over the next 15 to 20 years.