Roger W Ferguson, Jr: Interpreting labor market statistics in the context of
monetary policy
Remarks by Mr Roger W Ferguson, Jr, Vice-Chairman of the Board of Governors of the US Federal
Reserve System, to the Andrew Brimmer Policy Forum: National Economic and Financial Policies for
Growth, Employment, and the Improvement of Equity, at the 2005 Annual Convention, Allied Social
Science Associations, Philadelphia, 7 January 2005.
The references for the speech can be found on the Board of Governors of the Federal Reserve System's website.
* * *
In assessing the appropriate stance of monetary policy, policymakers must come to some judgment
about the likely future course of economic performance and, especially, of inflation. To make this
judgment, we find a useful concept to be the level of economic slack - defined as the difference
between the current level of output and the level of output the economy could produce if all available
resources were fully utilized. In many standard models of inflation, an economy operating above its
potential is associated with upward pressure on inflation, and an economy operating below its
potential is associated with downward pressure on inflation. Unfortunately, economic slack cannot be
measured directly but must instead be inferred from the variables we do observe.
Labor market measures have traditionally been a valuable source of information about economic
slack. In particular, statistics like the unemployment rate can tell us something about the amount of
available, but as yet unused, labor in the economy. But even this relation - between the unemployment
rate and the concept of economic slack - is not necessarily constant, and thus a given unemployment
rate may not indicate the same level of slack at two separate times. For example, shifts in the
composition of unemployed individuals across different skill levels, industries, or occupations relative
to the demand for workers with these characteristics can complicate this relationship, as can changes
in the behavior of the individuals who are out of work.
Moreover, the possibility of a change in the relationship between the unemployment rate and
economic slack is likely to be greater - and thus the signals from the labor market may be harder to
read - when the labor market behaves atypically, as in many respects it has behaved over the past
three years. A particular question that is difficult to answer is whether the slow recovery of employment
has left significant underutilized resources in the economy that could be readily re-employed, or
whether the lag in hiring indicates that the supply of those resources is relatively less forthcoming
given the state of demand?
In this context, I would like to discuss two aspects of the recent labor market downturn that have
received considerable attention and that have the potential to alter the relation between economic
slack and the unemployment rate. The first is the possibility that the extended weakness in the labor
market reflects permanent shifts in the composition of jobs - which is often referred to as industrial
restructuring. The second development I will address is the decline in labor force participation in recent
years.1 I should note, my comments today reflect only my views and should not be taken to represent
the views of my colleagues on the Board of Governors or in the Federal Reserve System.
Industrial restructuring
I will begin by providing some background on the current labor market recovery. As shown in chart 1,
which plots the level of private payroll employment relative to its level at the end of recessions, as
dated by the NBER, and compares employment performances across recoveries, the current recovery
in employment has been unusually slow - well below the average and even slower than during the
"jobless recovery" of the early 1990s. This relatively poor employment performance has been due
primarily to weak job creation. Though the rate of job destruction (chart 2, upper panel) rose at the
beginning of the recession, it soon dropped below that seen immediately before the recession. In
contrast, the pace of job creation (lower panel) continued to fall until the end of 2003, when
employment finally began to turn up. Finally, as chart 3 shows, the rise in the layoff rate since the end
permanent
of 2000 has been due primarily to an increase in layoffs.
To many observers, the coincidence of a large share of permanent job losses and sluggish job
creation indicates a pronounced shift in the optimal allocation of workers across firms or industries -
that is, an elevated pace of economic restructuring. The basic story is as follows: Permanent
reductions in employment in declining industries require workers to search for new jobs, a process
made difficult and more time consuming by the likelihood that the skills these workers acquired on
their previous jobs may be ill-suited to sectors of the economy in which labor demand is rising.
Although some workers may accept whatever job is available - whether or not it meets their longer-run
expectations for wages, benefits, or stability - our unemployment insurance system provides enough
protection that many will search longer for a good match and thus remain out of work longer.
Moreover, creating new jobs in expanding industries requires businesses to invest, and the most
recent recovery was marked, for some time, by a reluctance of businesses to do so. A slowing in the
pace of job creation resulted in limited new opportunities available to these displaced workers. Though
these stories sound plausible, restructuring is, in practice, difficult to measure, and alternative
measurement techniques have led to very different conclusions about the amount of restructuring that
has occurred in recent years.2
BIS Review 1/2005
Taking a somewhat different approach than previous analyses, we attempted to identify those
industries that have performed especially poorly since the 2001 business cycle peak and assess
whether these underperforming industries have been characterized by restructuring. We judged the
performance of each industry according to two criteria: (1) an industry's net employment change from
March 2001 to November 2004, and (2) the change in an industry's share of total employment
between March 2001 and November 2004 compared with the change in employment shares exhibited
over a pre-peak period of similar length.3
Table 1 ranks the performance of two-digit NAICS industries since March 2001 according to the first
measure of underperformance. In an absolute sense, the poorest performing industries include
durable and nondurable manufacturing, the information sector, retail trade, transportation and
warehousing, and professional and technical services. Moreover, four of those six industries - durable
manufacturing, information, transportation and warehousing, and professional and technical services -
also ranked among the six poorest performers according to the second criterion, which is based on
relative performance.
Table 1
Underperforming industries in terms of the change
in employment since the latest cyclical peak
(March 2001)
Industry Performance ranking1
Durable manufacturing 1
Nondurable manufacturing 2
Information 3
Retail trade 4
Transportation and warehousing 5
Professional and technical services 6
Wholesale trade 7
Company management 8
Utilities 9
Natural resources and mining 10
Arts, entertainment, and recreation 11
Real estate and leasing 12
Construction 13
Administrative support and waste 14
Other 15
Finance and insurance 16
Education 17
Accommodations and food services 18
Health care and social assistance 19
Note: Underlined industries ranked poorly according to both measures of underperformance.
1
A higher rank indicates worse performance.
Anecdotally, most of these industries can be associated with elements of restructuring. Within the
information industry, for example, telecommunications has suffered from overcapacity - and significant
downsizings or business failures - since the cyclical peak. Similarly, transportation includes the airline
industry in which many firms have been under stress, and professional and technical services includes
several industries that complement business investment and likely suffered in the wake of the sharp
slowing in spending on equipment and software early this decade. Within durable goods
manufacturing, computers and electronics, primary and fabricated metals, and machinery rank
particularly poorly according to our criteria of underperformance, and these industries have also been
identified with restructuring in recent years.
Corroborating this anecdotal evidence, the durable manufacturing, information, and professional and
technical services industries are also among the top six contributors to the post-peak increase in the
aggregate permanent layoff rate. These underperformers are also at the top of the list of industries
that experienced significant rates of job destruction during the labor market downturn of 2001 and
2002. In fact, the four industries that, according to our two criteria, were the key underperformers in
recent years more than accounted for the overall increase in the average pace of job destruction
between 1998-2000 and 2001-02.
Finally, the relationship between our measures of underperformance and industry productivity growth
is also informative about the importance of restructuring. Typically, productivity falls with employment
in recessions, as firms - hesitant to sever ties to workers who will be valuable to them when demand
recovers - reduce employment less than output. However, if firms perceive changes in demand to be
permanent, the reluctance to reduce employment in proportion to output should diminish. In fact,
productivity growth from 2000 to 2002 in the four key underperforming industries was not lower, on
average, than in industries not experiencing large reductions in labor demand, supporting the notion
that firms in these industries believed demand changes to have been permanent. Moreover, labor
market underperformance, in general, was associated with slightly greater productivity growth between
2000 and 2002; this association suggests that underperforming industries reacted to changes in labor
demand by destroying their least productive jobs - which is also consistent with the restructuring
hypothesis.
If our hypothesis that restructuring is associated with our four key underperforming industries is
correct, the influence of this restructuring on aggregate labor market outcomes would be substantial.
These industries, though together composing just 25 percent of private employment, accounted for net
job losses totaling nearly 2.6 million from the March 2001 business cycle peak through November
2004 (compared with a net decline of 1.2 million jobs for the private sector as a whole) and for about
half the deterioration in the average monthly employment change over this period relative to the
average pace before the peak.
Given this evidence that restructuring has been a notable feature of the labor market landscape in
recent years, it is also worth assessing the relevance of some possible explanations for the high
proportion of permanent job losses over this period. These explanations include technological change,
international competition, offshoring of less productive jobs, and large industry-specific demand
shocks, perhaps related to the 2001 terrorist attacks or the earlier overoptimism in the high-tech
sector.
To gauge the importance of these various explanations, we first examined the relationship between
industry employment and industry output using data for sixty three-digit NAICS industries. As can be
seen in chart 4, which plots the change in employment shares from 2000 to 2002 against the change
in value added shares over the same period, there is a strong positive correlation between these
changes, both for all industries and for the subset of industries that make up the four restructuring
sectors we identified previously. In the chart, industries in this subset, designated with an R, are
bunched in the lower left quadrant - an indication that most experienced declines in both employment
and output shares over this period. These positive correlations suggest that restructuring has been
caused mainly by adverse industry demand shocks rather than by positive supply shocks, although as
I will highlight later, there are some exceptions.
One possible source of these adverse demand shocks is increased international trade. To assess the
potential relationship between international trade and restructuring, we examined correlations between
changes in import and export shares and changes in employment shares for two-digit manufacturing
industries for the period from the start of the recession to the third quarter of 2004. We found it difficult
to discern any clear relationship in the data; this lack of clear relationship suggests that international
trade has not been an important determinant of the recent pattern of underperformance in the labor
market. Martin Baily and Robert Lawrence (2004) present a much more thorough analysis of this issue
and come to a similar conclusion.4
To investigate further the relationship between restructuring and labor productivity, we compared the
performance of industry employment to the performance of industry productivity for the period from
2000 to 2002 (chart 5). The fact that some industries experienced large declines in employment share
and well-above-average gains in productivity suggests that adverse demand shocks may not be the
only source of restructuring. Indeed, these industries include computer systems design, information
and data-processing services, and publishing (which includes software) - all high-tech categories that
have been associated either with positive technology shocks or with the outsourcing of low-productivity
jobs.
Overall, the evidence points to several tentative conclusions. First, although a period of permanent
employment declines is admittedly difficult to distinguish from an extended period of cyclical
weakness, the data, on balance, seem to indicate that restructuring has been an important
characteristic of the post-2000 labor market downturn. Second, except for a few high-tech industries,
restructuring appears to have been caused primarily by adverse shifts in the demand for the output of
restructuring industries rather than by positive supply shocks. Finally, any slowing of the current labor
market recovery from restructuring, if indeed restructuring has played such a part, has likely been due
to a slow transition of workers from restructuring industries to expanding industries rather than a slow
pace of restructuring in declining industries. The last conclusion is based on the absence of a positive
relation between employment share changes and industry productivity growth and on the high rates of
job destruction in underperforming industries, both of which suggest that restructuring industries
responded aggressively to adverse demand shocks.
Labor force participation
As I noted at the outset, a second anomaly that may have influenced the recent relationship between
the unemployment rate and economic slack is the behavior of the labor force participation rate.
Although the participation rate - adjusted for trend movements - tends to decrease when job prospects
are poor, recent declines have well exceeded the cyclical norm. In addition, though the unemployment
rate has fallen since the middle of 2003, the participation rate currently remains near the low point
reached in the first half of 2004. Together, these facts raise the question of whether economic slack is
being reflected increasingly in the participation rate rather than in the unemployment rate. The answer
to this question hinges on whether the recent declines in participation have been due to cyclical or to
more-permanent factors.
Distinguishing very long-term or permanent changes in labor supply from cyclical movements is
difficult, but some information can be brought to bear on this issue. First, demographic changes seem
not to be an important explanation of the decline in the participation rate. In general, one might expect
the aging baby-boom generation to put downward pressure on the participation rate, as this cohort
moves into their retirement years during which participation rates have traditionally been lower.
Although this possibility is clearly a concern for the future, changes in the age composition of the
population have, thus far, not accounted for much of the drop in the participation rate. Instead, the low
participation rate reflects pronounced declines in participation rates for a number of demographic
groups, most notably teenagers and young adults, as well as individuals between the ages of 25
and 44.
In addition, as can be seen in chart 6, the timing of the downturn in labor force participation lines up
closely with the weakening of economic activity that began in the second half of 2000. This
concordance suggests that the recent weakness in participation is more likely to be associated with
this business cycle than with an emerging downward trend, although one obviously cannot rule that
out.
Finally, we can perhaps learn something from the reasons that individuals give for being out of the
labor force. As shown in chart 7, the proportion of the population who say that they are out of the labor
force because they cannot find a job has increased only slightly. Instead, the rise in nonparticipation
since 2000 is associated with an increase in the proportions of individuals attending school, reporting
themselves as ill or disabled, or retired. Whether these patterns are more indicative of cyclical or of
structural changes in participation is difficult to pin down, however. Although the absence of a sizable
increase in discouraged workers might be viewed as evidence against a cyclical interpretation, the rise
in school enrollment may reflect a decline in the opportunity cost of attending school associated with
the lack of new job opportunities in a weak labor market. Similarly, the increase in disability rates - or
even, to some extent, retirement rates - could have both cyclical and structural elements.
In sum, the available information is far from definitive. The absence of any clear demographic shift
suggests that at least some portion of the unusually large declines in labor force participation has
been associated with this business cycle. Nevertheless, individuals who have recently exited the labor
force likely have weaker ties to the labor market than currently unemployed individuals. Thus, it is an
open question how quickly, if at all, recent increases in nonparticipation due to schooling, disability, or
retirement will be reversed.
BIS Review 1/2005
Restructuring and participation
As the number of puzzles concerning the labor market increases, so does the complexity of analysis
necessary to relate observed variables to concepts relevant for monetary policy. Thus, it seems
worthwhile to ask whether restructuring and the decline in participation might be part of the same
phenomenon. Such a relation does not seem implausible. As I noted previously, restructuring destroys
human capital specific to firms and industries and thus can significantly reduce the job opportunities
available to some workers. As the benefit to remaining in the labor market falls, these individuals may
become discouraged or choose to spend their time on activities outside the labor market, one of which
may be schooling or retraining to prepare for future reentry to the labor force.
To investigate this possibility further, we examined data from the most-recent displaced worker survey.
Table 2 shows the proportions of displaced workers from restructuring and nonrestructuring industries
(according to our classification scheme), as well as the shares of employment for these two groups of
industries.5 Qualitatively, the data are similar to those I have already presented: displaced workers
come disproportionately from restructuring industries. Of course, since more than half of displaced
workers come from other industries, restructuring at the industry level is, by no means, the only cause
of worker displacement. It is also true that displaced workers were more likely than other job losers to
have been out of the labor force in January 2004. Putting these facts together, it would not be
unreasonable to infer a linkage between restructuring and the decline in the participation rate.
Table 2
Distribution of employment and of displaced workers
by industry category
Industry Employment Displaced workers
Restructuring 23.1 42.2
Nonrestructuring 76.9 57.8
Total 100 100
Source: Displaced Worker Supplement to the CPS.
The labor market and monetary policy
Let me conclude my talk as I began it, stressing the importance to monetary policy of measuring
economic slack. As I've discussed, how much slack is indicated by the unemployment rate and other
labor market data depends both on the extent of industrial restructuring and on the causes of the
recent sharp declines in labor force participation. I believe that restructuring has been a visible part of
the recent downturn and that much of the recent unusual behavior of labor force participation reflects
cyclical forces. However, how we should adjust our interpretation of the unemployment rate as a
measure of economic slack depends on the magnitudes of these effects, about which much
uncertainty remains.
In such a situation, I view the conduct of monetary policy as a balancing of risks. One risk is that
industrial restructuring has been quite extensive. Because restructuring decreases the value of human
capital that is specific to downsizing industries, it acts, in effect, as a negative supply shock,
temporarily depressing the level of employment as the workers displaced by restructuring must either
search longer to find a job appropriate for their skills or seek retraining. An additional risk is that
declines in labor force participation have been predominantly structural, so that many of the individuals
who have exited the labor force over the past three years will be unlikely to return, at least in the near-
term. Under such conditions, the amount of economic slack could be very small, and thus expansive
monetary policy could lead to a pickup in inflationary pressures.
Alternatively, restructuring, though ongoing, may have resulted in relatively little mismatch between the
skills needed in restructuring industries and the skills demanded in expanding industries and, thus,
should not impede job creation. In addition, although the prolonged slow recovery in hiring may have
taken a greater toll on worker confidence than in earlier cycles, those workers who have recently
exited the labor force may not have significantly reduced their availability for work. In this scenario, a
substantial pool of unused labor may remain in the labor market, and an overly restrictive monetary
policy would prevent the economy from moving as quickly as possible to the level of full employment.
As you can see, transforming the information available from published statistics into concepts useful
for assessing the consequences of monetary policy is, in fact, quite complex. And, the evidence is
more ambiguous than one would like, indicating that it would be unwise to assume that labor market
indicators are complete predictors of slack. Nevertheless, I believe that our ability to interpret labor
market statistics will continue to benefit greatly from additional research on the topics I have discussed
today and from the exchange of ideas that this type of forum encourages.