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Bouncing Back From the Great Recession

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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Did the Great Recession inflict permanent damage on the U.S. economy? Or was it just a deep hole that took a long time to climb out of? Evidence now says that it was mostly the latter.

Based on how fast the U.S. recovered from the 2008 financial crisis and the recession that followed,  the speed hasn't been too different from that of other recessions during the past 30 years. Here, courtesy of Bill McBride, blogger at Calculated Risk, is a chart comparing job losses and recoveries in various U.S. recessions:

As you can see, the trajectory of the employment recovery after the Great Recession has been about the same as the recoveries following the 2001 and 1990 recessions. The main difference is that the Great Recession started with a deeper, more severe drop. Interestingly, the current recovery has lasted longer than the post-2001 recovery -- eight years after 2001, the U.S. was already in another recession, while the economy is still expanding today.

Other measures also show that the economy has mostly recovered. U6, the broadest official measure of unemployment -- which includes marginally attached workers plus those who are employed part-time for economic reasons -- is back down to the levels of 2004:

Official unemployment -- which doesn't include the marginally attached or part-time workers -- is down to 4.9 percent, a low rate by historical standards.

The steady recovery has mostly confounded the predictions of the so-called structuralists, who believed that the Great Recession caused the nation to transition to a permanently weaker economic footing. Tyler Cowen of George Mason University, for example, recently lost a bet with his colleague Bryan Caplan over the unemployment rate. Cowen bet Caplan in 2013 that unemployment would remain higher than 5 percent for 20 years. He was so confident in the explanatory power of structural factors that he gave Caplan 10-to-1 odds on the bet. It took only 2 1/2 years for Caplan to prevail.

Full Employment

Although Cowen protested that the employment-to-population ratio remains low, much of this is  due to the demographics. The retirement of the baby boomers is reducing the fraction of the population that is of working age. Once we adjust for demographic change, we find that the employment-to-population ratio has also mostly recovered from the Great Recession.

This recovery is a victory for mainstream macroeconomics. It validates the idea that economies restore themselves naturally after recessions -- especially with help from monetary and fiscal policy. In response to the big shock of 2008, the federal government in fact did exactly what textbook New Keynesian models say it should have done,  running large but temporary deficits, lowering interest rates almost to zero and using unconventional monetary policy. The results weren’t exactly what the textbooks predicted -- inflation, for example, didn’t rise. But they were pretty close. The Great Recession can be read as a qualified success story for the dominant paradigm in macroeconomics.

However, it is wrong to say that employment has completely recovered. There are still some workers who didn't return to the labor force after 2008. They are small in number compared with the majority that have re-entered the ranks of the employed. But they do exist. We can see, for example, that labor force participation for Americans aged 25-54 has fallen a couple of percentage points from the highs of the late 1980s through the early 2000s.

Labor economists have also observed that the Beveridge Curve -- which measures the relationship between job vacancies and unemployment -- has shifted out, meaning that some companies may be having trouble finding qualified workers to fill their needs.

So although the U.S. has mostly recovered, we shouldn’t ignore the small but real long-term wounds that a small chunk of the population has suffered. Structural factors such as lower productivity, dysfunctional labor markets, reduced entrepreneurial dynamism and bad policy maybe be important, but they aren't the heart of the story. And as for the last few discouraged workers, the U.S. should be making efforts to identify them and get them back on their feet, while doing everything to ensure that the U.S. remains a good place to run a business.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net