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The Effect of Changes in Labor Markets on the Natural Rate of Employment [i] (April 2002)

handle is hein.congrec/cbo0705 and id is 1 raw text is: THE EFFECT OF CHANGES IN LABOR MARKETS ON THE NATURAL RATE OF UNEMPLOYMENT April 2002 NOTES All years referred to in the text and figures are calendar years, unless otherwise indicated. The figures in this report use shaded vertical bars to indicate periods of recession. The bars extend from the peak to the trough of each recession. PREFACE The Congressional Budget Office (CBO) is required to project the unemployment rate over a 10-year period. Such projections are closely linked to the concept of the natural rate of unemployment, the level of unemployment that would occur if aggregate demand for goods and services was in balance with aggregate supply. This paper summarizes and assesses recent research on the ways in which changes in the composition of the labor force and in the operation of labor markets may have affected the natural rate of unemployment. In particular, the experience of the late 1990s--when supply seemed to keep up with rapidly growing demand even though labor markets were tight, and the unemployment rate fell well below previous estimates of the natural rate--led many observers to speculate that the natural rate may have fallen substantially over the past two decades. This paper finds that several factors, most notably shifting demographics and the expansion of the temporary-help industry, have combined to reduce the natural rate significantly since the mid-I 980s. Some other factors, such as higher levels of skill and Internet job searching, may also have played a role in reducing the natural rate, but those factors have not been incorporated into CBO's projections for the next 10 years because they cannot now be quantified. David Brauer of CBO's Macroeconomic Analysis Division prepared this paper under the supervision of Robert Dennis and John Peterson. The manuscript benefited from suggestions by Arlene Holen, Deborah Lucas, Kim Kowalewski, Bob Arnold, Christopher Williams, Frank Russek, Kathy Ruffing, Ralph Smith, Bruce Vavrichek, and Paul Cullinan, all of CBO, as well as by Robert J. Gordon of Northwestern University and June O'Neill of Baruch College at the City University of New York. John McMurray provided research assistance. Christine Bogusz edited the paper, and Christian Spoor proofread it. Linda Lewis Harris prepared the report for publication, and Annette Kalicki produced the electronic versions for CBO's Web site.

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