Bernanke Seen Not Knowing Jobless Rate Below Fed Forecasts

David Waldrop, 59, says he considers himself retired after searching unsuccessfully for work comparable to the job he lost in July 2007 at the U.S. Department of Energy in Atlanta.

“There was certainly nothing in my area at my level,” he said. While the right opening might pull him back to employment, for now he sees his exit from the U.S. labor force as permanent. “I don’t see it happening,” he said. “I don’t see anything offering opportunities.”

Waldrop is one of millions who have dropped out of the labor market in the aftermath of the deepest recession since the Great Depression, causing the employment-to-population ratio to fall to 58.6 percent from 62.7 percent at the end of 2007. Federal Reserve Chairman Ben S. Bernanke says the decline reflects weakness in the economy that’s causing discouraged Americans to leave the workforce, bolstering his decision to add to his record monetary stimulus in January.

Economists at Barclays Capital, UBS AG and Moody’s Corp. disagree. They say the percentage of people aged 16 and older with jobs is shrinking permanently because of a structural shift as baby boomers like Waldrop retire. This will contribute to the jobless rate falling to 7.8 percent by December, below the Fed’s prediction of 8.2 percent to 8.5 percent, according to Drew Matus, senior U.S. economist at UBS and Dean Maki, chief U.S. economist at Barclays.

Photographer: Win McNamee/Getty Images

Federal Reserve Chairman Ben S Bernanke testifies before the Senate Banking, Housing and Urban Affairs Committee in Washington, March 1, 2012. Close

Federal Reserve Chairman Ben S Bernanke testifies before the Senate Banking, Housing... Read More

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Photographer: Win McNamee/Getty Images

Federal Reserve Chairman Ben S Bernanke testifies before the Senate Banking, Housing and Urban Affairs Committee in Washington, March 1, 2012.

Tighten Sooner

That may force Bernanke and his colleagues to tighten monetary policy sooner than their plan to keep the benchmark federal funds rate near zero until at least late 2014, or risk a surge in inflation, Matus and Maki predict. The policy-setting Federal Open Market Committee said after its March 13 meeting that “elevated” joblessness will “decline gradually,” in support of its rate pledge.

“Unemployment will come down faster, and the participation rate will be lower -- that is what they have been missing,” Matus said in a telephone interview from his Stamford, Connecticut, office. “Every month that goes by, and the labor market performs differently than they expect, they are going to have to ask themselves: Are they using the right models?”

Joblessness was 8.3 percent in February, the lowest in three years, after the most robust six-month period of employment growth since 2006. It had risen as high as 10 percent in October 2009. The Fed lowered its forecast in January, after predicting in November that unemployment would be 8.5 percent to 8.7 percent at the end of this year.

Natural Rate of Unemployment

The cause of lower participation is a key component in determining the so-called natural rate of unemployment, or the level that neither accelerates nor decelerates inflation. The Fed in January projected a “longer-run” jobless rate of 5.2 percent to 6 percent.

“If the goal became to restore the employment-to- population ratio to where it was prior to the recession, we’d need an unemployment rate of about 3 percent, and that would clearly lead to monetary policy being too easy for too long,” said Maki, who is based in New York. “We think this is a factor contributing to medium-term inflation risks.”

Inflation expectations have climbed this year, bond prices show. The break-even rate for five-year Treasury Inflation Protected Securities, the yield difference between the inflation-linked debt and comparable maturity Treasuries, was 2.16 percentage points on March 16. The rate, a measure of the outlook for consumer prices over the life of the securities, has climbed from 1.53 points on Dec. 16.

Slack ‘Remains Substantial’

Federal Reserve Bank of New York President William C. Dudley said today that “real economic activity has yet to be strong enough on a sustained basis to make a big dent in the overall amount of slack in the U.S. economy,” and he pointed to falling participation as support for his view that labor-market gains are exaggerated.

About half the drop in unemployment since September “was due to a declining labor-force participation rate,” Dudley said in a speech in Melville, New York. Had the rate not fallen “from around 66 percent in mid-2008 to under 64 percent in February, the unemployment rate would still be over 10 percent.”

It is “very important” to look not just at unemployment, Bernanke said in response to questions during a Senate Budget Committee hearing in Washington last month. “The 8.3 percent no doubt understates the weakness of the labor market in some broad sense.” Some people are leaving the workforce because they can’t find jobs, and others are taking part-time jobs because they can’t find full-time employment, he said.

Modest Recovery Pace

Charles Lieberman, chief investment officer at Advisors Capital Management LLC, said he supports Bernanke’s view, particularly given the modest pace of the recovery. The U.S. economy will grow 2.2 percent this year, according to the median response among 70 economists surveyed by Bloomberg News from March 9 to March 13. The U.S. expanded 1.7 percent in 2011.

“The unemployment rate has dropped more than would be expected, given the slow growth,” said Lieberman, former head of monetary analysis at the New York Fed and now in Hasbrouck Heights, New Jersey. “The pace of decline in unemployment will slow while the inflow back into the labor market is absorbed, unless growth accelerates significantly.”

While Bernanke argues that the falling participation rate reflects these cyclical changes, Fed researchers predicted in a 2006 study that the measure would decline because of structural shifts to the economy from the retirement of the generation born between 1946 and 1964.

‘Ignoring Their Own Work’

Bernanke and his FOMC colleagues “are really ignoring their own work on the subject,” Matus said.

The oldest boomers hit 65 in 2011, and every day for the next 17 years, about 10,000 more will reach the age historically associated with retirement, according to the Pew Research Center in Washington.

The 2006 Fed study predicted what the authors called a “conservative” three percentage-point decline in the participation rate during the next decade. It already has fallen 2.5 percentage points since the end of 2006, to 63.9 percent, with the participation rate among people in the prime working ages of 25 to 54 falling to 81.6 percent in February from 83.4 percent in January 2007.

Demographic Drivers

Demographics, not the poor economy, “are the driver” behind people leaving the workforce, Maki said. Only 15 percent of those between 25 and 54 years old who are exiting the labor market say they want a job, so it’s “completely unlikely” throngs of re-entrants will halt the drop in unemployment as Fed policy makers have suggested, he said.

The Bureau of Labor Statistics projects the participation rate will continue falling, to 62.5 percent in 2020 from 64.7 percent in 2010. While the rate for people 55 and older will rise, to an estimated 43 percent from 40 percent, the aging of America will produce the overall decline.

“Labor-force growth will be weaker for longer due to demographic forces, the expiration of emergency unemployment insurance and very low wage growth, which will keep potential workers from re-entering the workforce,” said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. He predicts the jobless rate will be 7.9 percent at the end of 2012 and 7.4 percent in December 2013.

“Odds are high that the Federal Reserve will raise interest rates well before the end of 2014,” he said.

‘Call Myself Retired’

Waldrop left the labor force when he gave up on his yearlong job hunt. Now “I call myself retired; I didn’t always,” Waldrop said. “I was unemployed for awhile.”

He said he was prepared for the transition, with a “very nice 401K,” and had “maxed out” contributions to his retirement funds in recent years. He’ll also draw Social Security as early as age 62, though he may delay that date to increase the monthly payments.

“It was always the plan to be able to retire at 55” if he chose to, he said. “I was forced into it because of the economy.”

To contact the reporters on this story: Caroline Salas Gage in New York at csalas1@bloomberg.net; Steve Matthews in Atlanta at smatthews@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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