Why Unemployment Won't Hit Double Digits
The labor market hasn't looked this gloomy since the dark days of the 1981-82 recession, one of the deepest downturns since the 1930s. At the recent pace of payroll declines, averaging more than 400,000 per month, job losses will surpass that slump's 2.8 million drop in employment by February. What's more, that recession lasted 16 months. The current slump, which began in December 2007, is almost certain to last longer. All this is raising serious questions about how high the unemployment rate will go this time. After all, joblessness peaked at 10.8% in the 1981-82 downturn, and weekly unemployment claims are already at levels not seen since then.
Are we headed for a double-digit jobless rate in 2009? Not unless this recession is deeper than even the most pessimistic forecasts for economic growth. Using a complex linkage between growth and unemployment developed by economist Arthur Okun in the early 1960s, economists at UBS (UBS) show that real gross domestic product would have to fall roughly 6% from peak to trough to yield a 10% unemployment rate by the end of 2009. That would imply a recession twice as deep as the 3% decline in GDP recorded in the 1981-82 downturn.
So why would a recession as steep as the one in 1981-82 result in a lower peak jobless rate in 2009? First of all, unemployment went into that recession at 7.5%, compared with 4.7% just before the current downturn. Productivity growth plays a key role in the relationship between growth and unemployment because it can influence the starting point for joblessness.
An increase in productivity growth over the past decade has enabled the economy to grow faster without igniting inflation. That allowed Federal Reserve policy to be more accommodative to growth, letting the jobless rate move lower without triggering inflation worries and tighter policy. Reflecting that lower starting point, the UBS economists note that a recession today as deep as the one in 1981-82 would imply a peak jobless rate of about 8.25%.
The rise in unemployment has picked up in recent months as businesses have reacted to the plunge in consumer spending. Until late summer, job losses had been mild because companies entered the recession having hired cautiously. Capital spending and inventory policies had also been conservative. Now the economy's weakness has overwhelmed those moderating factors, forcing steeper cuts.
That means the most severe losses in payrolls will be happening now and in the months ahead as companies slash costs and try to cushion their bottom lines. Still, comparisons with the 1981-82 experience must be tempered by the growth of both payrolls and the labor force, which includes workers with jobs and those looking for jobs. For example, payroll losses totaling 2.8 million back then, a 3.1% decline, would be equivalent to a drop of 4.3 million jobs today. Through November, payroll losses totaled 1.9 million, and December data, due on Jan. 9, will most likely raise that number.
Layoffs, as illustrated by new claims for unemployment insurance, zoomed higher at the end of 2008, portending more big payroll declines and higher unemployment in coming months. December claims averaged 573,000 per week, a level not seen since the peak monthly rate of 667,000 in 1982. However, that comparison exaggerates the implication for the unemployment rate. Adjusted for the 42% growth in the labor force, claims would still be less than their peak after the 1990-91 recession, when the jobless rate topped out at 7.8%. Today's equivalent of the 1982 apex in claims would be about 1 million per week.
The current recession could easily end up as deep as the 1981-82 downturn in terms of the fall in GDP. But given the massive policy efforts by the Federal Reserve, along with fiscal stimulus that may equal more than 2.5% of GDP in each of the next two years, a drop-off in growth big enough to push the jobless rate to 10% seems highly unlikely. Clearly, this is a bad recession. But not that bad.