The Recession of 2001 and Unemployment Insurance Financing

1. Introduction By the standard macroeconomic yardstick--the change in real GDP--the economic downturn of 2001 was one of the mildest of the past fifty years. Yet during 2002-04, several large states experienced difficulties financing their unemployment insurance (UI) programs. To date, nine state UI programs have secured loans to pay UI benefits. In addition to borrowing from the U.S. Treasury, the traditional source for loans, UI programs have borrowed from the private bond market and, in the case of Pennsylvania, from another agency of state government. Through the end of 2004, the U.S. labor market continued to exhibit softness, with unemployment in December totaling 8 million. Despite gains in employment, particularly during the second half of the year, the unemployment rate in 2004 averaged 5.5 percent and the seasonally adjusted rate did not descend below 5.4 percent in any month. Should the economic recovery stall or suffer a reverse, it is likely that some UI programs would have to borrow in 2005. From the perspectives of the labor market and UI program financing, the recession was more serious than one would infer simply from following the evolution of real GDP between 2001 and 2004. This paper examines the recent recession, with particular attention given to developments in the labor market and in UI program financing. Its three objectives are to describe developments in the macroeconomy and in the labor market that have relevance for UI funding issues, to present the important developments in UI financing associated with the 2001 recession (because primary responsibility for ensuring UI trust fund adequacy resides with the states, the discussion highlights developments in several states), and to discuss the borrowing options available to states whose trust fund reserves are inadequate. The pros and cons of alternative borrowing arrangements are also noted. The discussion identifies options but does not recommend a "preferred" method of borrowing. In choosing its financing strategy, a state must consider factors such as constitutional constraints, federal loan requirements, the size of the funding problem, interest rates on alternative debt instruments, and the terms and conditions of debt repayment. Finally, the paper summarizes the experiences of state UI programs that borrowed and repaid loans from the private bond market during earlier recessions. State UI programs function as a built-in or automatic stabilizer of the macroeconomy, with benefits payouts rising sharply during recessions. The pattern of recession-related benefits payments also reflects developments specific to each individual recession. Accordingly, we begin with a review of the 2001 downturn and recovery, to provide key background information for understanding recent UI funding experiences. 2. The Recession of 2001 The economic downturn of 2001 was mild--so mild, in fact, that its dating was not finally established until more than one year after its trough. In most post-World War II recessions, the quarterly decrease in real GDP was roughly 1 to 3 percent for one or two quarters, followed by a rebound in which real GDP growth often exceeded 4 percent for one or two quarters. During earlier episodes, changes in the unemployment rate occurred at nearly the same time as the changes in real GDP. For the eight recessions between 1949 and 1982, the month of highest unemployment occurred within four months of the month deemed to have been the trough by the experts at the National Bureau of Economic Research who officially date U.S. recessions. The recessions of the early 1990s and of 2001 differed in important respects from the earlier downturns. The decrease in real GDP has been smaller and the rebound in real GDP has been more modest. Probably most relevant for the present discussion, the time interval between the business cycle trough and the peak in unemployment has lengthened. …