economic paper

Journal of Economic Perspectives—Volume 26, Number 3—Summer 2012—Pages 3–26

TT he increase in the U.S. unemployment rate associated with the 2007–2009 he increase in the U.S. unemployment rate associated with the 2007–2009 recession is unprecedented during the post–World War II era. The unem-recession is unprecedented during the post–World War II era. The unem-ployment rate rose by 5.6 percentage points from a low of 4.4 percent in late ployment rate rose by 5.6 percentage points from a low of 4.4 percent in late 2006 and early 2007 to 10.0 percent in October 2009; this exceeds the net increase of 2006 and early 2007 to 10.0 percent in October 2009; this exceeds the net increase of 5.2 percentage points between mid-1979 and late 1982 (which spans two recessionary 5.2 percentage points between mid-1979 and late 1982 (which spans two recessionary episodes). Moreover, in contrast to relatively rapid labor market recoveries following episodes). Moreover, in contrast to relatively rapid labor market recoveries following prior, deeper, post–World War II recessions, two and a half years into this recovery, prior, deeper, post–World War II recessions, two and a half years into this recovery, as of early 2012, the unemployment rate had declined by only about 1.7 percentage as of early 2012, the unemployment rate had declined by only about 1.7 percentage points. Such persistently anemic labor market conditions are partly a refl ection of the points. Such persistently anemic labor market conditions are partly a refl ection of the sluggish overall economic recovery, a common occurrence following fi nancial crises sluggish overall economic recovery, a common occurrence following fi nancial crises (Reinhart and Rogoff 2009; Jordà, Schularick, and Taylor 2011). The lackluster pace (Reinhart and Rogoff 2009; Jordà, Schularick, and Taylor 2011). The lackluster pace of job creation has barely kept up with trend labor force growth and therefore has of job creation has barely kept up with trend labor force growth and therefore has not generated enough jobs to make a signifi cant dent in the unemployment rate or not generated enough jobs to make a signifi cant dent in the unemployment rate or substantially reduce unemployment duration. Moreover, as we will discuss in more substantially reduce unemployment duration. Moreover, as we will discuss in more detail later, the unemployment rate has remained high relative to its historical rela-detail later, the unemployment rate has remained high relative to its historical rela- tionship with other business cycle indicators, such as job vacancy rates.tionship with other business cycle indicators, such as job vacancy rates.

The disconnect between the unemployment rate and other indicators of aggre-The disconnect between the unemployment rate and other indicators of aggre- gate economic conditions has raised the concern that rather than being purely gate economic conditions has raised the concern that rather than being purely cyclical, U.S. unemployment now contains a substantial structural component that cyclical, U.S. unemployment now contains a substantial structural component that will persist even after the U.S. economy has fully recovered from the recession. In will persist even after the U.S. economy has fully recovered from the recession. In

A Search and Matching Approach to Labor Markets: Did the Natural Rate of Unemployment Rise?

■ ■ Mary C. Daly is Associate Director of Research and Group Vice President, Bart Hobijn is Senior Research Adviser, and Robert G. Valletta is Research Adviser, all at the Federal Reserve Bank of San Francisco, San Francisco, California. Ayşegül Şahin is Assistant Vice President, Federal Reserve Bank of New York, New York City, New York. Daly is the corresponding author at ⟨⟨[email protected] ⟩⟩..

http://dx.doi.org/10.1257/jep.26.3.3. doi=10.1257/jep.26.3.3

Mary C. Daly, Bart Hobijn, Ayşegül Şahin, and Robert G. Valletta

4 Journal of Economic Perspectives

turn, this concern implies that the full employment or “natural” rate of unemploy-turn, this concern implies that the full employment or “natural” rate of unemploy- ment is now higher than it was before the recession. The distinction is crucial from ment is now higher than it was before the recession. The distinction is crucial from a policy perspective, because in general, short-run monetary and fi scal stabiliza-a policy perspective, because in general, short-run monetary and fi scal stabiliza- tion policies are designed to address a cyclical shortfall in labor demand rather tion policies are designed to address a cyclical shortfall in labor demand rather than structural factors in the labor market; such structural factors may include a than structural factors in the labor market; such structural factors may include a mismatch between workers’ skills or geographic locations and employers’ labor mismatch between workers’ skills or geographic locations and employers’ labor needs, or the effects of changes in the generosity of social welfare programs. needs, or the effects of changes in the generosity of social welfare programs. However, understanding how much of the sustained high level of unemployment is However, understanding how much of the sustained high level of unemployment is cyclical or structural is a challenging task, a point emphasized by Diamond (2011) cyclical or structural is a challenging task, a point emphasized by Diamond (2011) in his recent Nobel Prize Lecture and illustrated by the wide span of views on the in his recent Nobel Prize Lecture and illustrated by the wide span of views on the topic held by economists and policymakers.topic held by economists and policymakers.

In this paper, we use a search and matching framework to assess the degree to In this paper, we use a search and matching framework to assess the degree to which the natural rate of unemployment has changed and the reasons underlying which the natural rate of unemployment has changed and the reasons underlying any changes. In the fi rst section, we discuss the implications of a standard textbook any changes. In the fi rst section, we discuss the implications of a standard textbook model of frictional unemployment based on a search and matching framework model of frictional unemployment based on a search and matching framework (Pissarides 2000, chap. 1). This model specifi es two curves—the Beveridge curve (Pissarides 2000, chap. 1). This model specifi es two curves—the Beveridge curve and the job creation curve—that capture labor supply and labor demand factors, as and the job creation curve—that capture labor supply and labor demand factors, as refl ected in the unemployment and job vacancy rates, and that interact to determine refl ected in the unemployment and job vacancy rates, and that interact to determine equilibrium frictional unemployment. Using this framework, we estimate that the equilibrium frictional unemployment. Using this framework, we estimate that the natural rate of unemployment has increased over the recession and recovery, but by natural rate of unemployment has increased over the recession and recovery, but by far less than unemployment has risen. Our preferred estimate indicates an increase far less than unemployment has risen. Our preferred estimate indicates an increase in the natural rate of unemployment of about one percentage point during the in the natural rate of unemployment of about one percentage point during the recession and its immediate aftermath, putting the current natural rate at around recession and its immediate aftermath, putting the current natural rate at around 6 percent. Importantly, even at the maximum of our range of plausible estimates, 6 percent. Importantly, even at the maximum of our range of plausible estimates, we fi nd the natural rate increased by only about one and a half percentage points, we fi nd the natural rate increased by only about one and a half percentage points, which would boost the current natural rate to about 6.6 percent. For context, the which would boost the current natural rate to about 6.6 percent. For context, the highest natural rate in the last few decades as estimated by the Congressional Budget highest natural rate in the last few decades as estimated by the Congressional Budget Offi ce (2011) was 6.3 percent in 1978.Offi ce (2011) was 6.3 percent in 1978.

In the second part of the analysis, we focus on the three primary factors that In the second part of the analysis, we focus on the three primary factors that economists have offered that may account for an increase in the natural rate of economists have offered that may account for an increase in the natural rate of unemployment: 1) a unemployment: 1) a mismatch between the characteristics of job openings, such as between the characteristics of job openings, such as skill requirements or location, and the characteristics of the unemployed; 2) the skill requirements or location, and the characteristics of the unemployed; 2) the availability of availability of extended unemployment insurance benefi ts, which may reduce the intensity benefi ts, which may reduce the intensity of job search or cause some recipients to claim they are looking for work, which is of job search or cause some recipients to claim they are looking for work, which is a requirement for benefi ts receipt, when they have in fact effectively left the work-a requirement for benefi ts receipt, when they have in fact effectively left the work- force; and 3) force; and 3) uncertainty about economic conditions, which may have induced fi rms to , which may have induced fi rms to focus their efforts on raising productivity and output without extensive hiring of focus their efforts on raising productivity and output without extensive hiring of new employees.new employees.11 We argue that the increase in mismatch has been quite limited. We We argue that the increase in mismatch has been quite limited. We fi nd a larger contribution arising from extended unemployment insurance benefi ts, fi nd a larger contribution arising from extended unemployment insurance benefi ts, although this effect is likely to disappear when such benefi ts are allowed to expire. although this effect is likely to disappear when such benefi ts are allowed to expire.

1 More broadly, this evidence will draw upon our previous work on the labor market during the recession and recovery: Daly and Hobijn (2010), Elsby, Hobijn, and Şahin (2010), Kwok, Daly, and Hobijn (2010), Valletta and Kuang (2010a, b), as well as Wilson (2010).

Mary C. Daly, Bart Hobijn, Ayşegül Şahin, and Robert G. Valletta 5

Finally, we provide speculative evidence that the unusual degree of uncertainty may Finally, we provide speculative evidence that the unusual degree of uncertainty may be contributing to elevated unemployment through the resulting suppression of be contributing to elevated unemployment through the resulting suppression of hiring; again, this factor would be expected to ease as these uncertainties are resolved.hiring; again, this factor would be expected to ease as these uncertainties are resolved.

Overall, we conclude that although the natural rate of unemployment has risen Overall, we conclude that although the natural rate of unemployment has risen to a moderate degree over the last few years, substantial slack remains in the labor to a moderate degree over the last few years, substantial slack remains in the labor market and is likely to persist for several years. Moreover, since most of the increase market and is likely to persist for several years. Moreover, since most of the increase in the natural rate appears to be transitory, we expect that as the cyclical recovery in the natural rate appears to be transitory, we expect that as the cyclical recovery in the labor market proceeds, the natural rate will fall back to a value close to its in the labor market proceeds, the natural rate will fall back to a value close to its pre-recession level of around 5 percent.pre-recession level of around 5 percent.

The Equilibrium Natural Rate of Unemployment in a Search Model

The equilibrium natural rate of unemployment is the average rate of unem-The equilibrium natural rate of unemployment is the average rate of unem- ployment that would prevail in the absence of business cycle fl uctuations (Brauer ployment that would prevail in the absence of business cycle fl uctuations (Brauer 2007). Underlying the natural rate is frictional unemployment, which refl ects 2007). Underlying the natural rate is frictional unemployment, which refl ects the normal time that the unemployed spend in job search, and structural unem-the normal time that the unemployed spend in job search, and structural unem- ployment, which refl ects mismatches between employers’ labor demand and the ployment, which refl ects mismatches between employers’ labor demand and the skills and geographic location of the unemployed; the two terms are often used skills and geographic location of the unemployed; the two terms are often used synonymously. The natural rate is conceptually similar but not identical to the non-synonymously. The natural rate is conceptually similar but not identical to the non- accelerating infl ation rate of unemployment, or NAIRU, which defi nes equilibrium accelerating infl ation rate of unemployment, or NAIRU, which defi nes equilibrium unemployment as the rate at which price infl ation is not changing.unemployment as the rate at which price infl ation is not changing.

The concept of a natural rate was originally introduced by Milton Friedman The concept of a natural rate was originally introduced by Milton Friedman (1968) and Edmond Phelps (1968) as a way to distinguish between cyclical swings (1968) and Edmond Phelps (1968) as a way to distinguish between cyclical swings in unemployment that monetary policy can affect and structural changes that it in unemployment that monetary policy can affect and structural changes that it cannot. Under the standard neoclassical assumption of fully fl exible prices for cannot. Under the standard neoclassical assumption of fully fl exible prices for factors of production and output, the natural rate is primarily determined by the factors of production and output, the natural rate is primarily determined by the characteristics of workers and the effi ciency of the labor market matching process. characteristics of workers and the effi ciency of the labor market matching process. These factors affect the rate at which jobs are simultaneously created and destroyed, These factors affect the rate at which jobs are simultaneously created and destroyed, the rate of turnover in particular jobs, and how quickly unemployed workers are the rate of turnover in particular jobs, and how quickly unemployed workers are matched with vacant positions. Given the severe shock to labor markets in the most matched with vacant positions. Given the severe shock to labor markets in the most recent recession and the unusually vigorous expansion in a narrow set of housing-recent recession and the unusually vigorous expansion in a narrow set of housing- related and fi nancial sectors that preceded the downturn, it is reasonable to ask related and fi nancial sectors that preceded the downturn, it is reasonable to ask whether some of these noncyclical factors have been altered in a way that increases whether some of these noncyclical factors have been altered in a way that increases the natural rate of unemployment in either the short or the long term.the natural rate of unemployment in either the short or the long term.

Frictional Unemployment in Equilibrium To assess the factors affecting the unemployment rate in the short run as well as To assess the factors affecting the unemployment rate in the short run as well as

its longer-run level, we rely on the model of equilibrium frictional unemployment its longer-run level, we rely on the model of equilibrium frictional unemployment from Pissarides (2000, chap. 1). In this model, equilibrium unemployment is deter-from Pissarides (2000, chap. 1). In this model, equilibrium unemployment is deter- mined by the intersection of two curves: the Beveridge curve (BC), which depicts mined by the intersection of two curves: the Beveridge curve (BC), which depicts a negative relationship between vacancies (job openings) and the unemployment a negative relationship between vacancies (job openings) and the unemployment rate, and the job creation curve (JCC), which refl ects employers’ decisions to rate, and the job creation curve (JCC), which refl ects employers’ decisions to create job openings and can loosely be interpreted as an aggregate labor demand create job openings and can loosely be interpreted as an aggregate labor demand

6 Journal of Economic Perspectives

curve. We use this framework to analyze the potential increase in the natural rate of curve. We use this framework to analyze the potential increase in the natural rate of unemployment. Daly, Hobijn, and Valletta (2011) offer further details and a formal unemployment. Daly, Hobijn, and Valletta (2011) offer further details and a formal presentation of the underlying model.presentation of the underlying model.

In frictionless models of the labor market, wages adjust to equate labor demand In frictionless models of the labor market, wages adjust to equate labor demand to labor supply in a spot market, which excludes the existence of unemployment as to labor supply in a spot market, which excludes the existence of unemployment as an equilibrium outcome. However, in labor market models with search frictions, not an equilibrium outcome. However, in labor market models with search frictions, not every employer that is looking to hire fi nds a worker, and not every job searcher fi nds every employer that is looking to hire fi nds a worker, and not every job searcher fi nds an employer. Therefore, the labor market does not fully clear in each period, and an employer. Therefore, the labor market does not fully clear in each period, and some job openings remain unfi lled at the same time that some job seekers remain some job openings remain unfi lled at the same time that some job seekers remain unemployed. Because employers and job seekers each benefi t from a job match, wages unemployed. Because employers and job seekers each benefi t from a job match, wages are determined by the bargain between employers and employees over the surplus are determined by the bargain between employers and employees over the surplus generated by the match, which occurs after the match.generated by the match, which occurs after the match.22 So the equilibrium in this So the equilibrium in this model is defi ned in terms of vacancies and unemployment—the intersection of the BC model is defi ned in terms of vacancies and unemployment—the intersection of the BC and JCC—rather than wages and the equilibrium level of employment. Figure 1 (based and JCC—rather than wages and the equilibrium level of employment. Figure 1 (based on Figure 1.2 in Pissarides 2000, p. 20) depicts a typical BC and JCC relationship.on Figure 1.2 in Pissarides 2000, p. 20) depicts a typical BC and JCC relationship.

To understand how the Beveridge curve and job creation curve interact to To understand how the Beveridge curve and job creation curve interact to produce equilibrium vacancy and unemployment rates, it is useful to review the produce equilibrium vacancy and unemployment rates, it is useful to review the determinants of each curve separately. As implied in the original research of its determinants of each curve separately. As implied in the original research of its

2 Assumptions about the type of wage bargaining are important for the cyclical properties of the model (Pissarides 2009) but are not important for the equilibrium concept we focus on here.

Figure 1 Determinants of Shifts in Equilibrium Unemployment

Source: Authors.

Job Creation Curve ( JCC)

V ac

an cy

r at

e (v

)

Unemployment rate (u)

JCC′

BC′

Beveridge Curve (BC)

a

b

c

Did the Natural Rate of Unemployment Rise? 7

namesake (Beveridge 1944) and formalized in subsequent research, the Beveridge namesake (Beveridge 1944) and formalized in subsequent research, the Beveridge curve is essentially a production possibility frontier for the job matching capabilities curve is essentially a production possibility frontier for the job matching capabilities of the labor market, where the rate at which job seekers are matched to job openings of the labor market, where the rate at which job seekers are matched to job openings depends primarily on the ratio of the vacancy rate to the unemployment rate (Dow depends primarily on the ratio of the vacancy rate to the unemployment rate (Dow and Dicks-Mireaux 1958; Blanchard and Diamond 1989; Petrongolo and Pissarides and Dicks-Mireaux 1958; Blanchard and Diamond 1989; Petrongolo and Pissarides 2001). The job vacancy rate is constructed (analogous to the unemployment rate) as a 2001). The job vacancy rate is constructed (analogous to the unemployment rate) as a ratio of the number of vacancies to the sum of the total employed plus the number of ratio of the number of vacancies to the sum of the total employed plus the number of vacancies. It measures the incidence of open but unfi lled jobs in the economy. Move-vacancies. It measures the incidence of open but unfi lled jobs in the economy. Move- ment along the BC refl ects cyclical changes in aggregate labor demand: for example, ment along the BC refl ects cyclical changes in aggregate labor demand: for example, as labor demand weakens, vacancies decline and the unemployment rate rises, causing as labor demand weakens, vacancies decline and the unemployment rate rises, causing movement towards the lower right in the diagram. By contrast, an outward shift in movement towards the lower right in the diagram. By contrast, an outward shift in the overall position of the BC refl ects a decline in the effi ciency of the job matching the overall position of the BC refl ects a decline in the effi ciency of the job matching process: for a given level of vacancies, workers have more trouble fi nding acceptable process: for a given level of vacancies, workers have more trouble fi nding acceptable jobs, and for a given level of unemployment, fi rms have more trouble fi nding suit-jobs, and for a given level of unemployment, fi rms have more trouble fi nding suit- able workers.able workers.33 All else equal, reduced matching effi ciency will raise the frictional or All else equal, reduced matching effi ciency will raise the frictional or structural level of unemployment, hence the natural rate of unemployment.structural level of unemployment, hence the natural rate of unemployment.

As Figure 1 shows, the Beveridge curve by itself does not determine an equilibrium As Figure 1 shows, the Beveridge curve by itself does not determine an equilibrium combination of vacancies and unemployment. This requires the job creation curve, combination of vacancies and unemployment. This requires the job creation curve, which is determined by fi rms’ recruiting behavior. Firms hire workers to produce which is determined by fi rms’ recruiting behavior. Firms hire workers to produce output and will create vacancies up to the point where the expected value of a job output and will create vacancies up to the point where the expected value of a job match equals the expected search cost to fi ll the vacancy. The expected value of a match equals the expected search cost to fi ll the vacancy. The expected value of a job match is determined by the marginal product of labor. The expected search cost job match is determined by the marginal product of labor. The expected search cost combines fi rms’ direct recruiting expenses with the probability that a job is fi lled.combines fi rms’ direct recruiting expenses with the probability that a job is fi lled.

In the basic model we discuss here, the probability of fi lling a job rises with In the basic model we discuss here, the probability of fi lling a job rises with the unemployment rate. Thus, the job creation curve is upward sloping, implying the unemployment rate. Thus, the job creation curve is upward sloping, implying that fi rms create more job openings when unemployment is higher (as depicted in that fi rms create more job openings when unemployment is higher (as depicted in Figure 1). The exact degree of upward slope is affected by other factors that may Figure 1). The exact degree of upward slope is affected by other factors that may change over time or across the business cycle, such as the job separation rate, the change over time or across the business cycle, such as the job separation rate, the level of recruiting costs, and the value of jobs (as refl ected in worker productivity level of recruiting costs, and the value of jobs (as refl ected in worker productivity and the value of output). More generally, the slope of the JCC depends on the and the value of output). More generally, the slope of the JCC depends on the structure of the product and labor markets in which fi rms operate and how they structure of the product and labor markets in which fi rms operate and how they bargain over wages, as well as external factors such as the discount or interest rate.bargain over wages, as well as external factors such as the discount or interest rate.

Changes in the expected value of a job associated with changes in the marginal Changes in the expected value of a job associated with changes in the marginal product of labor can shift the job creation curve (as depicted in Figure 1). This product of labor can shift the job creation curve (as depicted in Figure 1). This is a channel through which shifts in aggregate demand can affect the unemploy-is a channel through which shifts in aggregate demand can affect the unemploy- ment rate even when the effi ciency of the job matching process is unchanged. For ment rate even when the effi ciency of the job matching process is unchanged. For example, in recessions, declines in aggregate demand reduce the marginal product example, in recessions, declines in aggregate demand reduce the marginal product of labor, which reduces the value of creating jobs. This causes the JCC to rotate of labor, which reduces the value of creating jobs. This causes the JCC to rotate

3 Petrongolo and Pissarides (2001) describe the derivation of the Beveridge curve from an underlying job matching technology and discuss functional forms for the job matching function. The BC is typically depicted as convex to the origin, which is consistent with job matching functions that have constant returns to scale in unemployment and vacancies (and hence diminishing returns to either factor with the other one fi xed).

8 Journal of Economic Perspectives

down, resulting in a higher unemployment rate with no shift in the Beveridge curve. down, resulting in a higher unemployment rate with no shift in the Beveridge curve. Although this decline in aggregate demand increases measured unemployment, Although this decline in aggregate demand increases measured unemployment, it does not raise the natural rate of unemployment. Theoretically, the JCC can it does not raise the natural rate of unemployment. Theoretically, the JCC can also shift in response to changes in fi rm search costs. If the probability of fi lling a also shift in response to changes in fi rm search costs. If the probability of fi lling a vacancy falls, for example due to a rise in skill mismatch, the JCC will rotate down, vacancy falls, for example due to a rise in skill mismatch, the JCC will rotate down, indicating a lower rate of vacancies posted for a given job value.indicating a lower rate of vacancies posted for a given job value.

The key implication of this model is that the equilibrium unemployment rate is The key implication of this model is that the equilibrium unemployment rate is determined jointly by the intersection of the Beveridge curve and the job creation determined jointly by the intersection of the Beveridge curve and the job creation curve. In this framework, changes in the equilibrium unemployment rate, point curve. In this framework, changes in the equilibrium unemployment rate, point a in in Figur e 1, can occur due to an outward shift in the BC, a downward shift in the JCC, Figur e 1, can occur due to an outward shift in the BC, a downward shift in the JCC, or a combination of both. The example in Figu re 1 illustrates how shifts in these or a combination of both. The example in Figu re 1 illustrates how shifts in these curves can affect equilibrium unemployment. In the illustration, an outward shift in curves can affect equilibrium unemployment. In the illustration, an outward shift in the BC from BC to BCthe BC from BC to BC′′ shifts equilibrium unemployment from shifts equilibrium unemployment from a to to b. Since the JCC . Since the JCC is upward sloping, equilibrium unemployment increases by less than the outward is upward sloping, equilibrium unemployment increases by less than the outward shift in the BC. In this model, the unemployment rate can only increase by the same shift in the BC. In this model, the unemployment rate can only increase by the same amount as the rightward shift in the BC if the JCC is fl at or shifts outward (or down) amount as the rightward shift in the BC if the JCC is fl at or shifts outward (or down) as in JCas in JC′′. In these cases, equilibrium unemployment would move from . In these cases, equilibrium unemployment would move from b to to c..

One main message from this graphical illustration is that knowledge of the One main message from this graphical illustration is that knowledge of the Beveridge curve is not suffi cient to draw conclusions about equilibrium unemploy-Beveridge curve is not suffi cient to draw conclusions about equilibrium unemploy- ment. As the fi gure shows, it is not possible to infer, for a given shift in the BC, ment. As the fi gure shows, it is not possible to infer, for a given shift in the BC, how much the unemployment rate changes without knowing the shape of the job how much the unemployment rate changes without knowing the shape of the job creation curve. This point may seem obvious, but it has been overlooked in policy creation curve. This point may seem obvious, but it has been overlooked in policy discussions in which shifts in the BC are interpreted as one-for-one increases in the discussions in which shifts in the BC are interpreted as one-for-one increases in the natural rate of unemployment.natural rate of unemployment.

The insights from this model of equilibrium frictional unemployment point The insights from this model of equilibrium frictional unemployment point to two directions for empirical analysis. First, to understand the driving forces of to two directions for empirical analysis. First, to understand the driving forces of the rise in the unemployment rate, one must consider not only what is shifting the rise in the unemployment rate, one must consider not only what is shifting the Beveridge curve and by how much, but also what is affecting fi rms’ incentives the Beveridge curve and by how much, but also what is affecting fi rms’ incentives for job creation. Second, to distinguish what part of the rise in the unemployment for job creation. Second, to distinguish what part of the rise in the unemployment rate refl ects purely cyclical fl uctuations in labor demand and what parts are due to rate refl ects purely cyclical fl uctuations in labor demand and what parts are due to other factors, either transitory or permanent, that raise the natural rate, one has other factors, either transitory or permanent, that raise the natural rate, one has to consider what is driving the shifts in the BC and the JCC and how long these to consider what is driving the shifts in the BC and the JCC and how long these effects are likely to last. We consider these in turn.effects are likely to last. We consider these in turn.

Empirical Estimates of the Beveridge Curve Policymakers and analysts who have posited a rise in structural unemployment Policymakers and analysts who have posited a rise in structural unemployment

have largely focused on movements in the empirical Beveridge curve (for example, have largely focused on movements in the empirical Beveridge curve (for example, Benson 2011; Bernanke 2010; Kocherlakota 2010). As noted earlier, this focus is Benson 2011; Bernanke 2010; Kocherlakota 2010). As noted earlier, this focus is problematic on theoretical grounds, and here we show that empirically, there are problematic on theoretical grounds, and here we show that empirically, there are at least two diffi culties with relying on simple plots of the BC to make inferences at least two diffi culties with relying on simple plots of the BC to make inferences about changes in equilibrium unemployment. First, estimates of the shift in the about changes in equilibrium unemployment. First, estimates of the shift in the empirical BC suggest that the horizontal shift is not uniform but instead is larger at empirical BC suggest that the horizontal shift is not uniform but instead is larger at lower levels of the vacancy rate (as will be demonstrated below). Second, consistent lower levels of the vacancy rate (as will be demonstrated below). Second, consistent with an upward-sloping job creation curve, past horizontal shifts in the BC have with an upward-sloping job creation curve, past horizontal shifts in the BC have

Mary C. Daly, Bart Hobijn, Ayşegül Şahin, and Robert G. Valletta 9

been found upon later analysis to coincide with much smaller movements in the been found upon later analysis to coincide with much smaller movements in the estimated natural rate of unemployment (or the twin concept of the NAIRU).estimated natural rate of unemployment (or the twin concept of the NAIRU).44 This This fi nding underscores the empirical relevance of the other curve in the model—the fi nding underscores the empirical relevance of the other curve in the model—the JCC—which we also analyze empirically below.JCC—which we also analyze empirically below.

Figure 2 displays the empirical Beveridge curve based on data from the U.S. Figure 2 displays the empirical Beveridge curve based on data from the U.S. Bureau of Labor Statistics. It combines the offi cial unemployment rate formed Bureau of Labor Statistics. It combines the offi cial unemployment rate formed from the Bureau’s monthly household survey (the Current Population Survey) from the Bureau’s monthly household survey (the Current Population Survey) with data on job openings from the Job Openings and Labor Turnover Survey with data on job openings from the Job Openings and Labor Turnover Survey (JOLTS). The JOLTS is a monthly survey of about 16,000 establishments that was (JOLTS). The JOLTS is a monthly survey of about 16,000 establishments that was established relatively recently, with data fi rst becoming available in December 2000. established relatively recently, with data fi rst becoming available in December 2000.

4 The natural rate is not an observable entity. Rather it is estimated using historical information on the unemployment patterns of demographic subgroups or in the case of the NAIRU, generated from various Phillip’s curve models. Real-time estimates of the natural rate are frequently revised as a consensus forms regarding cyclical versus more structural adjustments in the data.

Figure 2 The U.S. Beveridge Curve, December 2000–November 2011

Sources: Job Openings and Labor Turnover Survey (JOLTS), Current Population Survey, and authors’ calculations. Notes: Data are monthly observations. The fi tted Beveridge curve is constructed using pre-2007-recession data. The fi tted and shifted Beveridge curves are calculated using the methodology introduced in Barnichon, Elsby, Hobijn, and Şahin (2010). The black dots indicate data since the 2007 recession.

5%

4%

3%

2%

1%

V ac

an cy

r at

e

Unemployment rate 2% 3% 4% 5% 6% 11%10%9%8%7%

ShiftedFitted

Since 2007 recession

Before 2007 recession

Gap 2.1%

Nov-11

10 Journal of Economic Perspectives

It focuses on job turnover, collecting information on job openings, hires, quits, It focuses on job turnover, collecting information on job openings, hires, quits, layoffs and discharges, and other separations. (JOLTS survey information is layoffs and discharges, and other separations. (JOLTS survey information is available online at available online at ⟨⟨http://www.bls.gov/jlt/home.htmhttp://www.bls.gov/jlt/home.htm⟩⟩.) The Beveridge curve .) The Beveridge curve in Figure 2 uses data for December 2000 through November 2011. The data are in Figure 2 uses data for December 2000 through November 2011. The data are divided into pre- and post-recession groups with observations occurring prior to divided into pre- and post-recession groups with observations occurring prior to the 2007–2009 recession labeled as lighter points and the observations occurring the 2007–2009 recession labeled as lighter points and the observations occurring since the recession labeled as darker points. The solid line represents an estimate since the recession labeled as darker points. The solid line represents an estimate of the empirical relationship between the unemployment and vacancy rates prior to of the empirical relationship between the unemployment and vacancy rates prior to the onset of the recession, based on the underlying transition rates between the the onset of the recession, based on the underlying transition rates between the labor force states of employment, unemployment, and out of the labor force labor force states of employment, unemployment, and out of the labor force (updated from Barnichon, Elsby, Hobijn, and Şahin 2010).(updated from Barnichon, Elsby, Hobijn, and Şahin 2010).

As noted previously, the position of the post-recession points relative to the As noted previously, the position of the post-recession points relative to the fi tted curve has been interpreted by some observers as evidence of a substantial fi tted curve has been interpreted by some observers as evidence of a substantial rightward shift in the Beveridge curve, indicating a higher unemployment rate for rightward shift in the Beveridge curve, indicating a higher unemployment rate for a given rate of job vacancies. The logic underlying this interpretation is illustrated a given rate of job vacancies. The logic underlying this interpretation is illustrated in Figure 2. In November 2011, the last point in our sample, the unemployment in Figure 2. In November 2011, the last point in our sample, the unemployment rate was 8.7 percent. Drawing a horizontal line from that point to the pre-recession, rate was 8.7 percent. Drawing a horizontal line from that point to the pre-recession, fi tted BC produces an unemployment gap of 2.1 percentage points.fi tted BC produces an unemployment gap of 2.1 percentage points.55

However, inferring an outward shift in the Beveridge curve in this manner However, inferring an outward shift in the Beveridge curve in this manner is problematic for three reasons. First, as the BC shifts right, it also tilts, so that is problematic for three reasons. First, as the BC shifts right, it also tilts, so that the horizontal shift is not uniform across all levels of the vacancy rate. To see the horizontal shift is not uniform across all levels of the vacancy rate. To see this, consider the shifted curve plotted as the dashed line in Figure 2, which is an this, consider the shifted curve plotted as the dashed line in Figure 2, which is an update of the estimated shifted BC in Barnichon, Elsby, Hobijn, and Şahin (2010). update of the estimated shifted BC in Barnichon, Elsby, Hobijn, and Şahin (2010). In this fi gure, the size of the horizontal shift in the BC varies across the vacancy In this fi gure, the size of the horizontal shift in the BC varies across the vacancy rate. At the November 2011 vacancy rate of 2.3 percent, the horizontal shift equals rate. At the November 2011 vacancy rate of 2.3 percent, the horizontal shift equals 2.1 percentage points; at a vacancy rate of 3.0 percent along the same curve, the 2.1 percentage points; at a vacancy rate of 3.0 percent along the same curve, the horizontal shift is only 1.6 percentage points. The concurrent shifting and tilting horizontal shift is only 1.6 percentage points. The concurrent shifting and tilting implies that estimates of the rightward shift in the BC at low vacancy rates will over-implies that estimates of the rightward shift in the BC at low vacancy rates will over- state the size of the shift at higher levels of the vacancy rate.state the size of the shift at higher levels of the vacancy rate.

Second, estimating real-time movements in the Beveridge curve is diffi cult Second, estimating real-time movements in the Beveridge curve is diffi cult because the size of the implied shift depends heavily on the specifi c month chosen. because the size of the implied shift depends heavily on the specifi c month chosen. In 2010 and 2011, estimates of the shift obtained in this manner varied from about In 2010 and 2011, estimates of the shift obtained in this manner varied from about 1.5 to over 3 percentage points. This large variation in the implied shift occurs 1.5 to over 3 percentage points. This large variation in the implied shift occurs because the recently observed points are near a very fl at part of the BC, which because the recently observed points are near a very fl at part of the BC, which combines large changes in the unemployment rate with small changes in vacancy combines large changes in the unemployment rate with small changes in vacancy rates. In other words, the concavity or fl attening of the BC at high unemployment rates. In other words, the concavity or fl attening of the BC at high unemployment rates means that the outward shift implied by a specifi c increase in the vacancy rate rates means that the outward shift implied by a specifi c increase in the vacancy rate is not uniform, but rather increases as unemployment rises.is not uniform, but rather increases as unemployment rises.

Finally, as noted in earlier research, the movement of vacancies and unemploy-Finally, as noted in earlier research, the movement of vacancies and unemploy- ment back to the stable Beveridge curve following a labor market shock typically follows ment back to the stable Beveridge curve following a labor market shock typically follows

5 The size of the imputed current gap is not very sensitive to the estimation method applied. The nonlinear ordinary least squares estimate in Valletta and Kuang (2010b) yields a similar size gap, as does the recalibrated version of Shimer’s (2007) Beveridge curve model presented by Kocherlakota (2010).

Did the Natural Rate of Unemployment Rise? 11

a counterclockwise adjustment pattern (for example, Bowden 1980; Blanchard and a counterclockwise adjustment pattern (for example, Bowden 1980; Blanchard and Diamond 1989). This pattern occurs because fi rms can adjust their targeted hiring (job Diamond 1989). This pattern occurs because fi rms can adjust their targeted hiring (job openings) rapidly when labor market conditions improve, but the matching process openings) rapidly when labor market conditions improve, but the matching process that will effectively reduce the unemployment rate lags behind the increase in labor that will effectively reduce the unemployment rate lags behind the increase in labor demand. As such, the unemployment-vacancy combinations observed in the aftermath demand. As such, the unemployment-vacancy combinations observed in the aftermath of a recession may primarily represent the labor market adjustment process back to a of a recession may primarily represent the labor market adjustment process back to a stable BC rather than an outward shift in the BC. For all of these reasons, it is diffi cult stable BC rather than an outward shift in the BC. For all of these reasons, it is diffi cult to draw defi nitive conclusions about shifts in the BC from the pattern of unemploy-to draw defi nitive conclusions about shifts in the BC from the pattern of unemploy- ment and vacancy rates observed in the aftermath of the recent severe recession.ment and vacancy rates observed in the aftermath of the recent severe recession.

Even if we were to take the range of monthly estimates as information about Even if we were to take the range of monthly estimates as information about recent shifts in the Beveridge curve, historical comparisons suggest that the recent recent shifts in the Beveridge curve, historical comparisons suggest that the recent rightward shift in the BC does not necessarily imply a similarly sized increase in the rightward shift in the BC does not necessarily imply a similarly sized increase in the NAIRU. Using a constructed series on job vacancies created by Barnichon (2010) NAIRU. Using a constructed series on job vacancies created by Barnichon (2010) that combines data from JOLTS with the Help-Wanted Index published by the that combines data from JOLTS with the Help-Wanted Index published by the Conference Board, Figure 3 plots historical BCs for the past six decades. Several Conference Board, Figure 3 plots historical BCs for the past six decades. Several facts are worth highlighting. First, the counterclockwise dynamics noted above, in facts are worth highlighting. First, the counterclockwise dynamics noted above, in which vacancies adjust more quickly than does unemployment in the aftermath of which vacancies adjust more quickly than does unemployment in the aftermath of

Figure 3 Historical Shifts in the Beveridge Curve, 1951–2011

Sources: BLS, Conference Board, Barnichon (2010), and authors’ calculations. Notes: Data are quarterly averages. Recession quarters are squares. The black dots are the 2000s and correspond to the part of the Beveridge curve displayed in Figure 2.

Unemployment rate 2% 4% 6% 12%10%8%

1%

V ac

an cy

r at

e

2%

3%

4%

5%

6%

1950s

1970s 1960s

1990s 1980s

2000s

12 Journal of Economic Perspectives

recessions, are evident in various past cycles. We labeled this pattern with arrows recessions, are evident in various past cycles. We labeled this pattern with arrows for each of the recessions in the fi gure. Second, as can be seen from the groupings for each of the recessions in the fi gure. Second, as can be seen from the groupings of data points by decade as labeled in the fi gure, the BC has shifted considerably of data points by decade as labeled in the fi gure, the BC has shifted considerably over time. The BC shifted rightward about 4 percentage points between the 1960s over time. The BC shifted rightward about 4 percentage points between the 1960s and the early 1980s and then shifted back about 2.5 percentage points between and the early 1980s and then shifted back about 2.5 percentage points between 1984 and 1989. Based on this history, the current outward shift of the BC is not 1984 and 1989. Based on this history, the current outward shift of the BC is not unusual, falling within the range of shifts that occurred during past business cycles. unusual, falling within the range of shifts that occurred during past business cycles. Most importantly perhaps, based on estimates now available, the variation in the Most importantly perhaps, based on estimates now available, the variation in the NAIRU over these periods was much smaller than the horizontal movement in NAIRU over these periods was much smaller than the horizontal movement in the Beveridge curve. Indeed, estimates of the NAIRU over these earlier periods the Beveridge curve. Indeed, estimates of the NAIRU over these earlier periods suggest that it may have changed by about half as much as the shift in the Beveridge suggest that it may have changed by about half as much as the shift in the Beveridge curve (for example, Brauer 2007; Orphanides and Williams 2002).curve (for example, Brauer 2007; Orphanides and Williams 2002).

An Estimate of the Long-Run Job Creation Curve To our knowledge, there are no existing estimates of the historical U.S. job To our knowledge, there are no existing estimates of the historical U.S. job

creation curve. We therefore provide a rudimentary estimate here. Although the creation curve. We therefore provide a rudimentary estimate here. Although the job creation curve can exhibit short-run movements, we focus on estimating its long-job creation curve can exhibit short-run movements, we focus on estimating its long- run shape, since we are mainly interested in establishing empirically the relationship run shape, since we are mainly interested in establishing empirically the relationship between unemployment and job vacancies in the absence of cyclical fl uctuations. between unemployment and job vacancies in the absence of cyclical fl uctuations. Our estimate is based on the theoretical relationships discussed earlier which showed Our estimate is based on the theoretical relationships discussed earlier which showed that the intersection of the BC and JCC gives us the equilibrium level of frictional that the intersection of the BC and JCC gives us the equilibrium level of frictional unemployment, or the natural rate. Based on this relationship we can use information unemployment, or the natural rate. Based on this relationship we can use information about the average vacancy rate at various values of the natural rate of unemployment about the average vacancy rate at various values of the natural rate of unemployment to estimate the natural rate of vacancies, or the vacancy rate in the absence of cyclical to estimate the natural rate of vacancies, or the vacancy rate in the absence of cyclical fl uctuations. This approach essentially takes the historical shifts in the Beveridge fl uctuations. This approach essentially takes the historical shifts in the Beveridge curve plotted in Figure 3 and translates them into a long-run job creation curve via curve plotted in Figure 3 and translates them into a long-run job creation curve via our current estimates of the natural rate that prevailed at those times.our current estimates of the natural rate that prevailed at those times.

The results of this exercise are shown in Fig ure 4, which plots quarterly obser-The results of this exercise are shown in Fig ure 4, which plots quarterly obser- vations from the historical vacancy rate series used in Figure 3 against the estimates vations from the historical vacancy rate series used in Figure 3 against the estimates of the natural rate of unemployment from the Congressional Budget Offi ce. Each of the natural rate of unemployment from the Congressional Budget Offi ce. Each of the vertical stacks of points on Figure 4 correspond to one of the Beveridge of the vertical stacks of points on Figure 4 correspond to one of the Beveridge curves plotted (and given decade labels) in Figure 3. So each point in the vertical curves plotted (and given decade labels) in Figure 3. So each point in the vertical stack represents the normal cyclical movements along a given Beveridge curve, or stack represents the normal cyclical movements along a given Beveridge curve, or alternatively, the cyclical fl uctuations in labor demand for a given natural rate of alternatively, the cyclical fl uctuations in labor demand for a given natural rate of unemployment. The dotted line shows the relationship between the average level unemployment. The dotted line shows the relationship between the average level of vacancies and the natural rate of unemployment in the U.S. economy over the of vacancies and the natural rate of unemployment in the U.S. economy over the sample period (1951:Q1 through 2011:Q3). The line comes from a regression of sample period (1951:Q1 through 2011:Q3). The line comes from a regression of the historical vacancy rate series on the natural rate of unemployment, using data the historical vacancy rate series on the natural rate of unemployment, using data points observed prior to the recent recession. The regression shows a statistically points observed prior to the recent recession. The regression shows a statistically signifi cant upward-sloping relationship between the average vacancy rate and the signifi cant upward-sloping relationship between the average vacancy rate and the natural rate of unemployment. We interpret this relationship as support for the view natural rate of unemployment. We interpret this relationship as support for the view that the long-run job creation curve is upward sloping.that the long-run job creation curve is upward sloping.

Of course, our estimate is rudimentary and, like the empirical Beveridge Of course, our estimate is rudimentary and, like the empirical Beveridge curve, based on data that could itself be mismeasured. For example, there is some curve, based on data that could itself be mismeasured. For example, there is some

Mary C. Daly, Bart Hobijn, Ayşegül Şahin, and Robert G. Valletta 13

disagreement on whether our data accurately capture the historical vacancy rate. disagreement on whether our data accurately capture the historical vacancy rate. Abraham (1987) points out that some of the variation in the Help-Wanted Index Abraham (1987) points out that some of the variation in the Help-Wanted Index data used for the construction of the historical vacancy rate time series refl ect a data used for the construction of the historical vacancy rate time series refl ect a longer-run trend due to the occupational mix of job openings, the consolidation in longer-run trend due to the occupational mix of job openings, the consolidation in the newspaper industry, and the increased requirements to post job openings for the newspaper industry, and the increased requirements to post job openings for Equal Employment Opportunity purposes. These factors likely drove up the index Equal Employment Opportunity purposes. These factors likely drove up the index relative to the actual number of vacancies during the period of rising unemploy-relative to the actual number of vacancies during the period of rising unemploy- ment in the 1970s and 1980s, which might lead to an overestimate of the slope of ment in the 1970s and 1980s, which might lead to an overestimate of the slope of the long-run job creation curve. Estimates of the natural rate of unemployment also the long-run job creation curve. Estimates of the natural rate of unemployment also can vary. Alternative estimates such as those computed by Orphanides and Williams can vary. Alternative estimates such as those computed by Orphanides and Williams (2002), which allow for greater time variation in the natural rate than the Congres-(2002), which allow for greater time variation in the natural rate than the Congres- sional Budget Offi ce estimate, produce a slightly fl atter JCC.sional Budget Offi ce estimate, produce a slightly fl atter JCC.

Putting the Empirical Beveridge Curve and Job Creation Curve Together To estimate the potential increase in the natural rate of unemployment To estimate the potential increase in the natural rate of unemployment

following the most recent recession, we combine our estimates of the pre-recession following the most recent recession, we combine our estimates of the pre-recession and shifted Beveridge curves from Figure 2 with the estimated long-run job creation and shifted Beveridge curves from Figure 2 with the estimated long-run job creation

Figure 4 Estimated Long-Run Job Creation Curve

Sources: Bureau of Labor Statistics, Congressional Budget Offi ce, and authors’ calculations. Notes: Seasonally adjusted quarterly data. Regression based on pre-2008 data. The black dots indicate data since the 2007 recession.

6%

5%

4%

3%

2%

1%

V ac

an cy

r at

e

Before 2007 recession

Since 2007 recession

4.5% 5.0% 5.5% 6.0% 6.5%

Natural rate of unemployment

Regression: Vacancy rate = –2.5 + 1.1 * Natural rate of unemployment, R 2 = 0.33

14 Journal of Economic Perspectives

curve from Fi gure 4. The results of this combination are presented in F igure 5. curve from Fi gure 4. The results of this combination are presented in F igure 5. As the fi gure shows, the empirical long-run JCC intersects the fi tted pre-recession As the fi gure shows, the empirical long-run JCC intersects the fi tted pre-recession Beveridge curve at slightly below a 5 percent unemployment rate, which is very Beveridge curve at slightly below a 5 percent unemployment rate, which is very close to the Congressional Budget Offi ce estimate of the pre-recession level of close to the Congressional Budget Offi ce estimate of the pre-recession level of the natural rate. The vacancy rate that coincides with this unemployment rate on the natural rate. The vacancy rate that coincides with this unemployment rate on the fi tted Beveridge curve is 3.1 percent. The shifted BC and the empirical long-run the fi tted Beveridge curve is 3.1 percent. The shifted BC and the empirical long-run JCC intersect at an unemployment rate of 5.5 percent. If one were to use alterna-JCC intersect at an unemployment rate of 5.5 percent. If one were to use alterna- tive time-varying estimates of the natural rate of unemployment, the estimated job tive time-varying estimates of the natural rate of unemployment, the estimated job creation curve would be fl atter, and the estimate of the natural rate would increase. creation curve would be fl atter, and the estimate of the natural rate would increase. For this reason, we interpret the 5.5 percent estimate as a lower bound on the For this reason, we interpret the 5.5 percent estimate as a lower bound on the current natural rate of unemployment. Conversely, if the job creation curve is fl at, current natural rate of unemployment. Conversely, if the job creation curve is fl at, then the increase in the natural rate is given by the 1.6 percentage point horizontal then the increase in the natural rate is given by the 1.6 percentage point horizontal shift in the Beveridge curve at the 3.1 percent vacancy rate. So our upper-bound shift in the Beveridge curve at the 3.1 percent vacancy rate. So our upper-bound estimate of the natural rate of unemployment is 6.6 percent. Thus, we fi nd that if estimate of the natural rate of unemployment is 6.6 percent. Thus, we fi nd that if the currently estimated shift in the Beveridge curve is permanent and the economy the currently estimated shift in the Beveridge curve is permanent and the economy returns to its long-run job creation curve, then the long-run natural rate of unem-returns to its long-run job creation curve, then the long-run natural rate of unem- ployment has increased from its 5 percent level in 2007 to somewhere between 5.5 ployment has increased from its 5 percent level in 2007 to somewhere between 5.5

Figure 5 Estimated Job Creation and Beveridge Curves

Sources: Job Openings and Labor Turnover Survey ( JOLTS), Current Population Survey, Congressional Budget Offi ce, and authors’ calculations. Notes: “BC” is “Beveridge curve.” “JCC” is “job creation curve.”

5%

4%

3%

2%

1%

V ac

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r at

e

Unemployment rate 4% 5% 6% 10%9%8%7%3%2%

Shifted BCFitted BC

Empirical JCC curve

Nov-11

5.5% 6.6%

Did the Natural Rate of Unemployment Rise? 15

and 6.6 percent as of November 2011.and 6.6 percent as of November 2011.66 In the absence of additional evidence to In the absence of additional evidence to pin down its exact value, we regard 6 percent, the approximate midpoint of this pin down its exact value, we regard 6 percent, the approximate midpoint of this range, as our preferred estimate of the current long-run natural rate of unemploy-range, as our preferred estimate of the current long-run natural rate of unemploy- ment. According to our estimate of the shifted BC, this 6 percent natural rate of ment. According to our estimate of the shifted BC, this 6 percent natural rate of unemployment corresponds to a new natural vacancy rate of 3.3 percent. This is unemployment corresponds to a new natural vacancy rate of 3.3 percent. This is substantially higher than the 3.0 percent natural vacancy rate associated with the substantially higher than the 3.0 percent natural vacancy rate associated with the pre-recession natural rate of unemployment and fi tted Beveridge curve.pre-recession natural rate of unemployment and fi tted Beveridge curve.

Implications for Potential GDP In November 2011, the unemployment rate was 8.7 percent, 2.7 percentage In November 2011, the unemployment rate was 8.7 percent, 2.7 percentage

points above our estimate of the new natural rate, while the vacancy rate was points above our estimate of the new natural rate, while the vacancy rate was 2.3 percent, 1.0 percentage point lower than the new natural vacancy rate. This 2.3 percent, 1.0 percentage point lower than the new natural vacancy rate. This 2.7 percentage point unemployment gap, by defi nition, refl ects an ongoing cyclical 2.7 percentage point unemployment gap, by defi nition, refl ects an ongoing cyclical shortfall in the demand for labor associated with the recent recession.shortfall in the demand for labor associated with the recent recession.

This shortfall in labor demand, or unemployment gap, can be mapped into a This shortfall in labor demand, or unemployment gap, can be mapped into a measure of the shortfall in the level of overall economic activity relative to the level measure of the shortfall in the level of overall economic activity relative to the level that would have occurred in the absence of the business cycle. The latter measure that would have occurred in the absence of the business cycle. The latter measure is known as potential GDP and the percentage difference between actual GDP and is known as potential GDP and the percentage difference between actual GDP and potential GDP is known as the output gap. The relatively stable statistical relation-potential GDP is known as the output gap. The relatively stable statistical relation- ship between these unemployment and output gaps over a long historical period ship between these unemployment and output gaps over a long historical period is known as Okun’s Law, named after Arthur Okun (1962). Figure 6 shows Okun’s is known as Okun’s Law, named after Arthur Okun (1962). Figure 6 shows Okun’s Law based on the output and unemployment gaps implied by the Congressional Law based on the output and unemployment gaps implied by the Congressional Budget Offi ce’s (2011) historical estimates of potential GDP and the natural rate of Budget Offi ce’s (2011) historical estimates of potential GDP and the natural rate of unemployment. The fi gure suggests that, as a reasonable rule of thumb, for every unemployment. The fi gure suggests that, as a reasonable rule of thumb, for every percentage point that the unemployment rate exceeds its natural rate, GDP drops percentage point that the unemployment rate exceeds its natural rate, GDP drops two percentage points below its potential.two percentage points below its potential.

During the recession and in 2009 and 2010, we saw historically large devia-During the recession and in 2009 and 2010, we saw historically large devia- tions from the unemployment/GDP relationship implied by Okun’s Law, with the tions from the unemployment/GDP relationship implied by Okun’s Law, with the unemployment rate being as much as a percentage point higher than implied by unemployment rate being as much as a percentage point higher than implied by the GDP gap. This was refl ected in high average labor productivity growth during the GDP gap. This was refl ected in high average labor productivity growth during that period (Daly and Hobijn 2010). However, the decline in the unemployment that period (Daly and Hobijn 2010). However, the decline in the unemployment rate in the fi rst quarter of 2011, combined with revised and slower GDP growth, has rate in the fi rst quarter of 2011, combined with revised and slower GDP growth, has brought the unemployment and output gaps back in line with the historical Okun’s brought the unemployment and output gaps back in line with the historical Okun’s Law relationship.Law relationship.

Our analysis above suggested that the natural rate of unemployment is likely to Our analysis above suggested that the natural rate of unemployment is likely to be about a percentage point higher than the Congressional Budget Offi ce estimate be about a percentage point higher than the Congressional Budget Offi ce estimate used in Figure 6. In that case, the unemployment gap would be a percentage point used in Figure 6. In that case, the unemployment gap would be a percentage point lower as well and, to be in line with Okun’s Law, potential GDP would be about lower as well and, to be in line with Okun’s Law, potential GDP would be about

6 As the recovery has proceeded, our estimated range for the natural rate has been falling. For example, in January 2011 we estimated the range to be bounded at 6.9 percent rather than the 6.6 percent we fi nd currently. We interpret this decline as partially refl ecting data revisions to JOLTS and partially refl ecting the evolution of unemployment and vacancies in 2011. The latter of these two points highlights the transitory nature of recent changes in the natural rate, which we discuss in more detail below.

16 Journal of Economic Perspectives

2 percent less than the current CBO estimate, which amounts to $332 billion of 2 percent less than the current CBO estimate, which amounts to $332 billion of annual GDP. The corrected output gap in 2011Q3 would be 4.9 percent rather than annual GDP. The corrected output gap in 2011Q3 would be 4.9 percent rather than 6.9 percent.6.9 percent.

In the context of the IS-LM/AS-AD framework that is often used in textbooks on In the context of the IS-LM/AS-AD framework that is often used in textbooks on macroeconomics (for example, Abel, Bernanke, and Croushore 2011, chap. 9), this macroeconomics (for example, Abel, Bernanke, and Croushore 2011, chap. 9), this conclusion implies that the shortfall of actual GDP relative to its full employment conclusion implies that the shortfall of actual GDP relative to its full employment level, often referred to as “economic slack,” is less than the CBO estimates. However, level, often referred to as “economic slack,” is less than the CBO estimates. However, even if the output gap since the beginning of the recession was 2 percentage points even if the output gap since the beginning of the recession was 2 percentage points lower than currently estimated by the Congressional Budget Offi ce, this recession lower than currently estimated by the Congressional Budget Offi ce, this recession would still be the second-deepest of the last 60 years, after that of the early 1980s.would still be the second-deepest of the last 60 years, after that of the early 1980s.

What is Shifting the Beveridge and Job Creation Curves?

What factors affect the positions of the Beveridge and job creation curve s? What factors affect the positions of the Beveridge and job creation curve s? Table 1 lists the fi ve factors we consider. The factors are divided into two groups: Table 1 lists the fi ve factors we consider. The factors are divided into two groups: cyclical factors that cause a shortfall in aggregate demand and higher layoff rates, cyclical factors that cause a shortfall in aggregate demand and higher layoff rates,

Figure 6 Okun’s Law

Sources: U.S. Bureau of Economic Analysis, Bureau of Labor Statistics, Congressional Budget Offi ce, and authors’ calculations. Note: The black dots indicate data since the 2007 recession.

6

5

4

3

2

1

0

–1

–2

–3

–4

U n

em p

lo ym

en t

ga p

( p

er ce

n t)

Since 2007 recession

2011Q3

Before 2007 recession

–10 –8 –6 –4 –2 0 2 4 6

Output gap (percent)

Mary C. Daly, Bart Hobijn, Ayşegül Şahin, and Robert G. Valletta 17

and structural or noncyclical factors that have a persistent effect on the natural and structural or noncyclical factors that have a persistent effect on the natural rate of unemployment. In our discussion below, we ignore the fi rst two (cyclical) rate of unemployment. In our discussion below, we ignore the fi rst two (cyclical) factors in the table and focus on the other factors because our intent is to identify factors in the table and focus on the other factors because our intent is to identify changes in the natural rate of unemployment that are independent of persistent changes in the natural rate of unemployment that are independent of persistent shortfalls in aggregate demand. Weak aggregate demand drives the shortfall in shortfalls in aggregate demand. Weak aggregate demand drives the shortfall in labor demand that depresses job creation and, for a given Beveridge curve, gener-labor demand that depresses job creation and, for a given Beveridge curve, gener- ates cyclical movements along a fi xed Beveridge curve. Elevated layoffs are closely ates cyclical movements along a fi xed Beveridge curve. Elevated layoffs are closely related to weak aggregate demand since layoffs typically rise when aggregate related to weak aggregate demand since layoffs typically rise when aggregate demand weakens. An increase in the rate of layoffs can cause an outward shift in demand weakens. An increase in the rate of layoffs can cause an outward shift in the Beveridge curve, suggesting that an increase in layoffs contributed to the shifts the Beveridge curve, suggesting that an increase in layoffs contributed to the shifts that we estimated above. However, variation in layoff rates tend to play an important that we estimated above. However, variation in layoff rates tend to play an important role during the onset of recessions, when labor demand plunges, but a limited role role during the onset of recessions, when labor demand plunges, but a limited role during recoveries, when labor demand improves.during recoveries, when labor demand improves.77 Since the measured layoffs rate Since the measured layoffs rate from the JOLTS data has returned to its pre-recession levels, we do not consider from the JOLTS data has returned to its pre-recession levels, we do not consider them a concern for the labor market recovery going forward and therefore do not them a concern for the labor market recovery going forward and therefore do not address them here.address them here.

In the remainder of this section we provide recent empirical evidence on the In the remainder of this section we provide recent empirical evidence on the potential importance of each of the structural/noncyclical factors in Table 1 and potential importance of each of the structural/noncyclical factors in Table 1 and discuss whether these factors are likely to be transitory or permanent.discuss whether these factors are likely to be transitory or permanent.

Mismatch The mismatch argument for sustained increases in the unemployment rate The mismatch argument for sustained increases in the unemployment rate

and the natural rate of unemployment is predicated on imbalances in labor supply and the natural rate of unemployment is predicated on imbalances in labor supply and demand across industry sectors, geographic areas, or skill groups. Of course, and demand across industry sectors, geographic areas, or skill groups. Of course, labor markets always display a certain degree of mismatch—or else all job vacancies labor markets always display a certain degree of mismatch—or else all job vacancies would fi ll immediately. However, any rise in mismatch above its usual level makes would fi ll immediately. However, any rise in mismatch above its usual level makes it harder than usual for workers to fi nd a job and more expensive for fi rms to fi ll it harder than usual for workers to fi nd a job and more expensive for fi rms to fi ll a vacancy. The result is a decline in match effi ciency that both shifts the Beveridge a vacancy. The result is a decline in match effi ciency that both shifts the Beveridge

7 For U.S. evidence on this point, see among others, Darby, Haltiwanger, and Plant (1985, 1986) and Fujita and Ramey (2009). Elsby, Hobijn, and Şahin (2008) show that this is also true across countries.

Table 1 Factors that Move the Beveridge Curve (BC) and the Job Creation Curve (JCC)

Shifter JCC BC Transitory or Permanent

Cyclical factors Shortfall in aggregate demand ⇩ Transitory Elevated layoffs rate ⇩ ⇨ Transitory

Structural/Noncyclical factors Decrease in match effi ciency (mismatch) ⇩ ⇨ Mostly transitory Increased generosity of unemployment insurance ⇩ ⇨ Transitory Uncertainty ⇩ ⇨ Transitory

18 Journal of Economic Perspectives

curve out and the job creation curve down. In the case of the BC, mismatch makes curve out and the job creation curve down. In the case of the BC, mismatch makes it harder to form matches, moving the curve out. In the case of the JCC, mismatch it harder to form matches, moving the curve out. In the case of the JCC, mismatch increases the search cost to fi rms for a given job value, pushing the curve down. increases the search cost to fi rms for a given job value, pushing the curve down. Mismatch is often regarded as a main potential cause of a long-run increase in the Mismatch is often regarded as a main potential cause of a long-run increase in the natural rate since training or relocating workers and jobs take a substantial amount natural rate since training or relocating workers and jobs take a substantial amount of time.of time.

A highly uneven distribution of job gains and losses across industry sectors and A highly uneven distribution of job gains and losses across industry sectors and states is an indication of mismatch in the sense that it suggests that those who are states is an indication of mismatch in the sense that it suggests that those who are unemployed did not work in industries and regions where hiring is taking place. unemployed did not work in industries and regions where hiring is taking place. As shown in Figure 7, which displays the standard deviation of the rate of payroll As shown in Figure 7, which displays the standard deviation of the rate of payroll employment growth across 13 broad industry sectors that span the complete work-employment growth across 13 broad industry sectors that span the complete work- force, the dispersion of employment gains and losses across industries and states force, the dispersion of employment gains and losses across industries and states spiked in the most recent recession. This pattern is similar to past recessions, and spiked in the most recent recession. This pattern is similar to past recessions, and in fact the dispersion of employment gains and losses peaked at a lower level in the in fact the dispersion of employment gains and losses peaked at a lower level in the recent recession than in the recession of the mid-1970s. Moreover, as aggregate recent recession than in the recession of the mid-1970s. Moreover, as aggregate employment stabilized and has started to grow again, the dispersion of employ-employment stabilized and has started to grow again, the dispersion of employ- ment gains and losses across industries and states has returned to its pre-recession ment gains and losses across industries and states has returned to its pre-recession

Figure 7 Industry Mismatch

Sources: Bureau of Labor Statistics and authors’ calculations. Notes: The y -axis shows the standard deviation of payroll employment growth (12-month change) across 13 major industry categories, weighted by industry employment shares. The grey bars indicate recessions.

7

6

5

4

3

2

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201020052000199519901985198019751970

Did the Natural Rate of Unemployment Rise? 19

level. This suggests very little sectoral imbalance in employment growth during the level. This suggests very little sectoral imbalance in employment growth during the nascent recovery. Valletta and Kuang (2010b) show that dispersion in employment nascent recovery. Valletta and Kuang (2010b) show that dispersion in employment growth growth across states also has returned to its pre-recession level. also has returned to its pre-recession level.

Even though the dispersion of employment gains and losses across industries Even though the dispersion of employment gains and losses across industries and states has declined substantially, a large number of unemployed workers remain and states has declined substantially, a large number of unemployed workers remain who previously held jobs in sectors like construction and fi nancial activities. Since who previously held jobs in sectors like construction and fi nancial activities. Since these sectors will probably take a fair amount of time to return to their pre-recession these sectors will probably take a fair amount of time to return to their pre-recession employment levels, these workers might suffer from prolonged spells of unemploy-employment levels, these workers might suffer from prolonged spells of unemploy- ment due to skill mismatch.ment due to skill mismatch.

To address this possibility, Şahin, Song, Topa, and Violante (2011) introduce To address this possibility, Şahin, Song, Topa, and Violante (2011) introduce mismatch indices that combine measures of both labor demand and labor supply. mismatch indices that combine measures of both labor demand and labor supply. For labor demand, they use vacancy data from the Job Openings and Labor Turnover For labor demand, they use vacancy data from the Job Openings and Labor Turnover Survey and the Conference Board’s Help Wanted OnLine database, while for labor Survey and the Conference Board’s Help Wanted OnLine database, while for labor supply they rely on unemployment measures from the Current Population Survey. supply they rely on unemployment measures from the Current Population Survey. These indices show that both sectoral as well as occupational mismatch increased These indices show that both sectoral as well as occupational mismatch increased during the recession but geographic mismatch across states remained relatively during the recession but geographic mismatch across states remained relatively low. At the industry level, this increase can be traced back to the construction, low. At the industry level, this increase can be traced back to the construction, durable goods manufacturing, health services, and education sectors. Occupational durable goods manufacturing, health services, and education sectors. Occupational mismatch rose mostly due to the construction, production work, healthcare, and mismatch rose mostly due to the construction, production work, healthcare, and sales-related occupations. Şahin, Song, Topa, and Violante (2011) also quantify how sales-related occupations. Şahin, Song, Topa, and Violante (2011) also quantify how much of the recent rise in U.S. unemployment is due to an increase in mismatch much of the recent rise in U.S. unemployment is due to an increase in mismatch and fi nd that higher mismatch across industries and occupations accounts for 0.6 and fi nd that higher mismatch across industries and occupations accounts for 0.6 to 1.7 percentage points of the recent rise in the unemployment rate. Geographical to 1.7 percentage points of the recent rise in the unemployment rate. Geographical mismatch turns out to be quantitatively insignifi cant.mismatch turns out to be quantitatively insignifi cant.88

These fi ndings linking mismatch to the observed unemployment rate do not These fi ndings linking mismatch to the observed unemployment rate do not necessarily imply that the underlying natural rate of unemployment increased by necessarily imply that the underlying natural rate of unemployment increased by the same amount as the contribution of mismatch to the rise in the unemployment the same amount as the contribution of mismatch to the rise in the unemployment rate. Just like the dispersion measures considered in Valletta and Kuang (2010b), rate. Just like the dispersion measures considered in Valletta and Kuang (2010b), the mismatch indices constructed by Şahin, Song, Topa, and Violante (2011) rose the mismatch indices constructed by Şahin, Song, Topa, and Violante (2011) rose during the recession and then started to decline in 2010. Thus far, the evidence during the recession and then started to decline in 2010. Thus far, the evidence suggests that mismatch has had a pronounced cyclical component, moving together suggests that mismatch has had a pronounced cyclical component, moving together with the unemployment rate. While mismatch has contributed to the increase in with the unemployment rate. While mismatch has contributed to the increase in the unemployment rate, its current path suggests that it is not likely to cause a large the unemployment rate, its current path suggests that it is not likely to cause a large long-lasting increase in the natural rate of unemployment.long-lasting increase in the natural rate of unemployment.

We do expect a modest increase in the natural rate due to the contraction We do expect a modest increase in the natural rate due to the contraction of the construction sector. A simple back-of-the-envelope calculation also supports of the construction sector. A simple back-of-the-envelope calculation also supports this view. The seasonally adjusted unemployment rate for construction workers has this view. The seasonally adjusted unemployment rate for construction workers has been hovering in the range of 15 to 20 percent during the recovery, compared been hovering in the range of 15 to 20 percent during the recovery, compared

8 This result for geographic mismatch is consistent with recent empirical papers, most notably Molloy, Smith, and Wozniak (2011) and Schulhofer-Wohl (2010), and Valletta (2010) which all fi nd a very limited role for geographic immobility of unemployed individuals whose home values have fallen below the amount owed on their mortgages (“house lock”). Recent theoretical work by Sterk (2010) suggests that although house lock will lead to an outward shift in the Beveridge curve, the likely shift is much smaller than the one depicted in Figure 2.

20 Journal of Economic Perspectives

with a more typical rate from 2003 to 2006 of about 7 to 8 percent. This represents with a more typical rate from 2003 to 2006 of about 7 to 8 percent. This represents about 1.25 million more unemployed construction workers in the current recovery about 1.25 million more unemployed construction workers in the current recovery than was typical during the preceding expansion. Assuming that half of them are than was typical during the preceding expansion. Assuming that half of them are re-employable in other industries—a plausible estimate given the recent evidence re-employable in other industries—a plausible estimate given the recent evidence on industry mobility of workers (for example, Bjelland, Fallick, Haltiwanger, and on industry mobility of workers (for example, Bjelland, Fallick, Haltiwanger, and McEntarfer 2010)—the decline of construction would cause structural unemploy-McEntarfer 2010)—the decline of construction would cause structural unemploy- ment to increase by only about 0.4 percentage point. Because most construction ment to increase by only about 0.4 percentage point. Because most construction workers are not hired through formal job openings, we expect the effect of this type workers are not hired through formal job openings, we expect the effect of this type of mismatch on the long-run job creation curve to be limited. Instead, we regard of mismatch on the long-run job creation curve to be limited. Instead, we regard this effect of mismatch on the natural rate of unemployment as mainly due to the this effect of mismatch on the natural rate of unemployment as mainly due to the persistent part of the contribution of the construction sector to the outward shift persistent part of the contribution of the construction sector to the outward shift of the Beveridge curve calculated by Barnichon, Elsby, Hobijn, and Şahin (2010).of the Beveridge curve calculated by Barnichon, Elsby, Hobijn, and Şahin (2010).

Extended Unemployment Benefi ts Extensions of unemployment insurance are a standard policy response to Extensions of unemployment insurance are a standard policy response to

elevated cyclical unemployment, and the sharp increase in the unemployment elevated cyclical unemployment, and the sharp increase in the unemployment rate during the 2007–2009 recession resulted in an unprecedented increase in the rate during the 2007–2009 recession resulted in an unprecedented increase in the potential duration of receipt for unemployment benefi ts. Beginning in June 2008, potential duration of receipt for unemployment benefi ts. Beginning in June 2008, the maximum duration of unemployment insurance benefi ts was extended multiple the maximum duration of unemployment insurance benefi ts was extended multiple times, reaching 99 weeks for most job seekers eligible for unemployment insurance times, reaching 99 weeks for most job seekers eligible for unemployment insurance as of late 2009.as of late 2009.99 Congress has allowed the primary extension program to expire twice, Congress has allowed the primary extension program to expire twice, most notably for nearly two months in June–July of 2010, but in each case renewed most notably for nearly two months in June–July of 2010, but in each case renewed the extensions, which as of this writing are effective through early March 2012.the extensions, which as of this writing are effective through early March 2012.

In the context of the job matching function described earlier, increased In the context of the job matching function described earlier, increased availability of unemployment insurance benefi ts is likely to increase the duration availability of unemployment insurance benefi ts is likely to increase the duration of unemployment through two primary behavioral channels. First, the extension of unemployment through two primary behavioral channels. First, the extension of unemployment insurance benefi ts, which represents an increase in their value, of unemployment insurance benefi ts, which represents an increase in their value, may reduce the intensity with which unemployed individuals eligible for these may reduce the intensity with which unemployed individuals eligible for these benefi ts search for work, along with their likelihood of accepting a given job offer. benefi ts search for work, along with their likelihood of accepting a given job offer. This occurs because the additional unemployment insurance benefi ts reduce the This occurs because the additional unemployment insurance benefi ts reduce the net gains from fi nding a job and also serve as an income cushion that helps house-net gains from fi nding a job and also serve as an income cushion that helps house- holds maintain acceptable consumption levels in the face of unemployment shocks holds maintain acceptable consumption levels in the face of unemployment shocks (Chetty 2008). Alternatively, the measured unemployment rate may be artifi cially (Chetty 2008). Alternatively, the measured unemployment rate may be artifi cially infl ated because some individuals who are not actively searching for work are iden-infl ated because some individuals who are not actively searching for work are iden- tifying themselves as active searchers in order to receive unemployment insurance tifying themselves as active searchers in order to receive unemployment insurance benefi ts (a “reporting effect,” in the language of Card, Chetty, and Weber 2007). benefi ts (a “reporting effect,” in the language of Card, Chetty, and Weber 2007). These behavioral effects on job search will increase the noncyclical or structural These behavioral effects on job search will increase the noncyclical or structural

9 The joint federal-state unemployment insurance program provides up to 26 weeks of normal benefi ts. The recent benefi t extensions refl ect the impact of two federally funded programs: the permanently authorized Extended Benefi ts program, which provides up to 20 additional weeks of benefi ts, and the special Emergency Unemployment Compensation, which provides up to 53 weeks of benefi ts, depending on the unemployment rate in the recipient’s state of prior employment (which causes the share of unemployed workers eligible for the 99-week maximum to change over time). The previous maximum eligibility was 65 weeks under the Federal Supplemental Benefi ts program in the mid-1970s.

Mary C. Daly, Bart Hobijn, Ayşegül Şahin, and Robert G. Valletta 21

component of the unemployment rate during the period over which extended component of the unemployment rate during the period over which extended benefi ts are available.benefi ts are available.1010

Assessing the magnitude of the extended unemployment insurance effect is chal-Assessing the magnitude of the extended unemployment insurance effect is chal- lenging—and the challenge is even more diffi cult under the unusually weak labor lenging—and the challenge is even more diffi cult under the unusually weak labor market conditions of the last few years, which by themselves have led to unusually market conditions of the last few years, which by themselves have led to unusually long unemployment durations. Based on existing empirical research using U.S. data, long unemployment durations. Based on existing empirical research using U.S. data, Chetty (2008) noted that a 10 percent increase in the overall value of unemployment Chetty (2008) noted that a 10 percent increase in the overall value of unemployment insurance benefi ts increases unemployment durations by 4–8 percent. Other esti-insurance benefi ts increases unemployment durations by 4–8 percent. Other esti- mates, particularly those that focus on extension periods rather than the dollar value mates, particularly those that focus on extension periods rather than the dollar value of benefi ts, lie below this range (for example, Card and Levine 2000). Thus, a wide of benefi ts, lie below this range (for example, Card and Levine 2000). Thus, a wide range of uncertainty exists around the impact of unemployment insurance extensions range of uncertainty exists around the impact of unemployment insurance extensions on the duration of unemployment. Moreover, as noted by others (for example, Katz on the duration of unemployment. Moreover, as noted by others (for example, Katz 2010), the effect of unemployment insurance benefi ts on job search likely was higher 2010), the effect of unemployment insurance benefi ts on job search likely was higher in the 1970s and 1980s than it is now, due to the earlier period’s greater reliance on in the 1970s and 1980s than it is now, due to the earlier period’s greater reliance on temporary layoffs and the corresponding sensitivity of recall dates to unemployment temporary layoffs and the corresponding sensitivity of recall dates to unemployment insurance benefi ts. As such, reliance on past estimates of the effects of the generosity insurance benefi ts. As such, reliance on past estimates of the effects of the generosity of unemployment insurance benefi ts on the duration on unemployment is likely to of unemployment insurance benefi ts on the duration on unemployment is likely to lead to overestimates in the current economic environment.lead to overestimates in the current economic environment.

Our own empirical assessment, reported in Daly, Hobijn, and Valletta (2011) Our own empirical assessment, reported in Daly, Hobijn, and Valletta (2011) and based on the methodology introduced in Valletta and Kuang (2010a), focuses and based on the methodology introduced in Valletta and Kuang (2010a), focuses on direct calculation and comparison of the duration of unemployment for indi-on direct calculation and comparison of the duration of unemployment for indi- viduals who are eligible or not eligible for unemployment insurance benefi ts, as viduals who are eligible or not eligible for unemployment insurance benefi ts, as refl ected in their reported reason for unemployment. The receipt of unemploy-refl ected in their reported reason for unemployment. The receipt of unemploy- ment insurance benefi ts generally is restricted to individuals who are unemployed ment insurance benefi ts generally is restricted to individuals who are unemployed through “no fault of their own,” to quote U.S. Labor Department eligibility guide-through “no fault of their own,” to quote U.S. Labor Department eligibility guide- lines, and have recent employment history that allows them to meet a base earnings lines, and have recent employment history that allows them to meet a base earnings test. In terms of the data on cause of unemployment from the Current Population test. In terms of the data on cause of unemployment from the Current Population Survey, individuals who are eligible for unemployment insurance are concentrated Survey, individuals who are eligible for unemployment insurance are concentrated among the unemployed who classify themselves as “job losers,” while those who are among the unemployed who classify themselves as “job losers,” while those who are ineligible tend to be voluntary job leavers and labor force entrants. The eligible ineligible tend to be voluntary job leavers and labor force entrants. The eligible ( job losers) group accounted for about two-thirds of the unemployed as of late ( job losers) group accounted for about two-thirds of the unemployed as of late 2009, which was very close to the share of actual unemployment insurance recipi-2009, which was very close to the share of actual unemployment insurance recipi- ents in overall unemployment.ents in overall unemployment.

During the recent recession and its aftermath, unemployment durations rose During the recent recession and its aftermath, unemployment durations rose substantially from their pre-recession baseline levels, both for those who are eligible substantially from their pre-recession baseline levels, both for those who are eligible for unemployment insurance and for others. According to the measure of expected for unemployment insurance and for others. According to the measure of expected completed duration used by Valletta and Kuang (2010a), duration approximately completed duration used by Valletta and Kuang (2010a), duration approximately doubled, from about 18 weeks to about 35 weeks. However, the increase in duration doubled, from about 18 weeks to about 35 weeks. However, the increase in duration

10 Our narrow focus on the direct behavioral effects of extended unemployment insurance ignores the potential aggregate demand stimulus provided by such benefi ts, which reduces the cyclical component of the unemployment rate but does not affect the level of structural unemployment. Some recent research suggests that multiplier effects of normal and extended unemployment insurance payments may be quite large (for example, Vroman 2010). It is possible that the reduction in cyclical unemployment from this channel may exceed the increase in the structural component from the micro-behavioral channel.

22 Journal of Economic Perspectives

of unemployment was larger for those eligible for unemployment benefi ts, by about of unemployment was larger for those eligible for unemployment benefi ts, by about 3½ weeks. If one attributes all of this difference to eligibility for extended unemploy-3½ weeks. If one attributes all of this difference to eligibility for extended unemploy- ment insurance benefi ts, which is the primary factor that differentially affected eligible ment insurance benefi ts, which is the primary factor that differentially affected eligible and ineligible individuals during the recession, then the extension of unemployment and ineligible individuals during the recession, then the extension of unemployment insurance raised the unemployment rate by about 0.8 percentage points. These results insurance raised the unemployment rate by about 0.8 percentage points. These results are relatively insensitive to alternative assumptions about the relationship between the are relatively insensitive to alternative assumptions about the relationship between the stated reason for unemployment in the Current Population Survey data and likely stated reason for unemployment in the Current Population Survey data and likely eligibility for unemployment insurance. Other recent formal estimates of the effect eligibility for unemployment insurance. Other recent formal estimates of the effect of extended unemployment insurance benefi ts on the natural rate of unemployment of extended unemployment insurance benefi ts on the natural rate of unemployment are generally smaller, ranging from about 0.1 to 0.7 percentage points (Aaronson, are generally smaller, ranging from about 0.1 to 0.7 percentage points (Aaronson, Mazumder, and Schecter 2010; Farber and Valletta 2011; Rothstein, forthcoming) up Mazumder, and Schecter 2010; Farber and Valletta 2011; Rothstein, forthcoming) up to a maximum of 1.2 percentage points (Fujita 2011).to a maximum of 1.2 percentage points (Fujita 2011).

The effect of extended unemployment insurance on the unemployment rate is The effect of extended unemployment insurance on the unemployment rate is expected to dissipate as labor market conditions improve and the extended unem-expected to dissipate as labor market conditions improve and the extended unem- ployment insurance provisions expire. As a result, the extensions of unemployment ployment insurance provisions expire. As a result, the extensions of unemployment insurance do not affect the long-run job creation curve.insurance do not affect the long-run job creation curve.1111 As extended unemploy- As extended unemploy- ment insurance provisions expire, the shifted Beveridge curve is expected to move ment insurance provisions expire, the shifted Beveridge curve is expected to move back inwards.back inwards.

Uncertainty Extensive anecdotal evidence suggests that the severity and persistence of Extensive anecdotal evidence suggests that the severity and persistence of

the recession and associated fi nancial crisis, combined with signifi cant changes the recession and associated fi nancial crisis, combined with signifi cant changes in federal government policies such as the Dodd–Frank fi nancial reform bill, the in federal government policies such as the Dodd–Frank fi nancial reform bill, the Patient Protection and Affordable Care Act, along with potential changes in energy Patient Protection and Affordable Care Act, along with potential changes in energy policy have increased fi rms’ uncertainty about the environment in which they are policy have increased fi rms’ uncertainty about the environment in which they are operating. In a labor market search framework with fi xed hiring and fi ring costs, operating. In a labor market search framework with fi xed hiring and fi ring costs, such uncertainty about the future state of aggregate demand lowers the option such uncertainty about the future state of aggregate demand lowers the option value of hiring new workers, thereby putting downward pressure on job creation value of hiring new workers, thereby putting downward pressure on job creation (Bentolila and Bertola 1990; Bloom 2009). According to such models, fi rms may (Bentolila and Bertola 1990; Bloom 2009). According to such models, fi rms may choose to incur the fi xed cost of investing in workers based on the option value choose to incur the fi xed cost of investing in workers based on the option value of using them when they are needed for production. As uncertainty about future of using them when they are needed for production. As uncertainty about future demand increases, the option value of making this up-front investment is reduced demand increases, the option value of making this up-front investment is reduced and fewer workers are demanded. In this way, uncertainty about economic condi-and fewer workers are demanded. In this way, uncertainty about economic condi- tions and policy might contribute to the outward shift in the Beveridge curve and, tions and policy might contribute to the outward shift in the Beveridge curve and, more importantly, to the low number of vacancies fi rms are posting.more importantly, to the low number of vacancies fi rms are posting.

Theoretical models of jobless recoveries, like Van Rens (2004) and Koenders Theoretical models of jobless recoveries, like Van Rens (2004) and Koenders and Rogerson (2005), suggest that fi rms might postpone hiring by temporarily and Rogerson (2005), suggest that fi rms might postpone hiring by temporarily boosting productivity growth. In Van Rens (2004), faster productivity growth comes boosting productivity growth. In Van Rens (2004), faster productivity growth comes from moving workers from the production of intangibles to the production of from moving workers from the production of intangibles to the production of

11 Extended unemployment insurance might raise current reservation wages and thus suppress job creation in the short run. No quantitative analysis of this short-run effect exists. However, we expect this short-run effect of extended unemployment insurance on the job creation curve to be small, because it is offset by the aggregate demand stimulus provided by unemployment insurance payments.

Did the Natural Rate of Unemployment Rise? 23

measured output. In Koenders and Rogerson (2005), fi rms choose to adopt orga-measured output. In Koenders and Rogerson (2005), fi rms choose to adopt orga- nizational changes that improve productivity but were temporarily shelved during nizational changes that improve productivity but were temporarily shelved during the prior expansion. In either case, the reorientation of production activity reduces the prior expansion. In either case, the reorientation of production activity reduces the rate of hiring but raises productivity growth. Effects of this sort might have the rate of hiring but raises productivity growth. Effects of this sort might have driven the signifi cant deviation from Okun’s Law in Figure 6 during 2009 and 2010 driven the signifi cant deviation from Okun’s Law in Figure 6 during 2009 and 2010 (Daly and Hobijn 2010). However, such temporary measures only raise productivity (Daly and Hobijn 2010). However, such temporary measures only raise productivity growth in the short run. If uncertainty remains elevated, the effect of these measures growth in the short run. If uncertainty remains elevated, the effect of these measures on productivity growth is likely to diminish and uncertainty will mainly reduce job on productivity growth is likely to diminish and uncertainty will mainly reduce job creation. This pattern is consistent with the combination of low productivity growth creation. This pattern is consistent with the combination of low productivity growth and low job creation in the fi rst half of 2011.and low job creation in the fi rst half of 2011.

Uncertainty might also cause fi rms that create vacancies to become more Uncertainty might also cause fi rms that create vacancies to become more selective about fi lling them. Such a change in fi rms’ hiring decisions would cause selective about fi lling them. Such a change in fi rms’ hiring decisions would cause a decline in the number of hires per vacancy; this is consistent with a reduction in a decline in the number of hires per vacancy; this is consistent with a reduction in recruiting intensity identifi ed by Davis, Faberman, and Haltiwanger (2010).recruiting intensity identifi ed by Davis, Faberman, and Haltiwanger (2010).

Though the high level of uncertainty is a possible explanation for the joint Though the high level of uncertainty is a possible explanation for the joint weakness in vacancy creation and vacancy yields (hires per vacancy) relative to weakness in vacancy creation and vacancy yields (hires per vacancy) relative to the strong productivity growth during the fi rst part of the recovery, we know of no the strong productivity growth during the fi rst part of the recovery, we know of no studies that have tried to quantify this effect. Since we expect fi rms’ uncertainty studies that have tried to quantify this effect. Since we expect fi rms’ uncertainty about the economic environment to dissipate as the recovery persists and gains about the economic environment to dissipate as the recovery persists and gains momentum, we anticipate that any increase in the natural rate of unemployment momentum, we anticipate that any increase in the natural rate of unemployment arising from uncertainty is likely to be temporary rather than permanent.arising from uncertainty is likely to be temporary rather than permanent.

Conclusion

The stubbornly high rate of unemployment in the face of ongoing GDP The stubbornly high rate of unemployment in the face of ongoing GDP growth and rising job openings has raised concerns that the level of structural growth and rising job openings has raised concerns that the level of structural unemployment, or the natural rate of unemployment, has risen over the past unemployment, or the natural rate of unemployment, has risen over the past few years in the United States. This possibility raises important policy issues since few years in the United States. This possibility raises important policy issues since short-run monetary and fi scal stabilization policies are not designed to alleviate short-run monetary and fi scal stabilization policies are not designed to alleviate structural unemployment and can be costly if misapplied. Our estimates suggest structural unemployment and can be costly if misapplied. Our estimates suggest that the natural rate of unemployment has risen from its pre-recession level of that the natural rate of unemployment has risen from its pre-recession level of 5.0 percent to a value between 5.5 and 6.6 percent, with our preferred estimate 5.0 percent to a value between 5.5 and 6.6 percent, with our preferred estimate lying at the midpoint of approximately 6 percent. This value implies an unem-lying at the midpoint of approximately 6 percent. This value implies an unem- ployment gap of over 2.7 percentage points in late 2011, which remains quite ployment gap of over 2.7 percentage points in late 2011, which remains quite high. Thus, even with a higher natural rate of unemployment, considerable slack high. Thus, even with a higher natural rate of unemployment, considerable slack remains in the labor market.remains in the labor market.

There are a number of unanswered questions for researchers in this area. Our There are a number of unanswered questions for researchers in this area. Our analysis relied on a rudimentary formulation and estimation of the job creation analysis relied on a rudimentary formulation and estimation of the job creation curve that relates fi rms’ decisions about job vacancies to the level of unemployment. curve that relates fi rms’ decisions about job vacancies to the level of unemployment. There may be factors that we have not identifi ed or measured well that perma-There may be factors that we have not identifi ed or measured well that perma- nently restrain vacancy and job creation going forward. Perhaps most vexing, the nently restrain vacancy and job creation going forward. Perhaps most vexing, the 2007–2009 recession is now the third successive one in which the U.S. economy has 2007–2009 recession is now the third successive one in which the U.S. economy has experienced a jobless recovery (that is, the rate of unemployment has remained experienced a jobless recovery (that is, the rate of unemployment has remained

24 Journal of Economic Perspectives

high for years after the recession is deemed to have ended). It is not yet clear high for years after the recession is deemed to have ended). It is not yet clear how to apply the common terminology of cyclical and structural unemployment how to apply the common terminology of cyclical and structural unemployment to this phenomenon. Is the U.S. economy now experiencing greater fl uctuations to this phenomenon. Is the U.S. economy now experiencing greater fl uctuations in structural unemployment than in the 1960s, 1970s, and 1980s? Or is it experi-in structural unemployment than in the 1960s, 1970s, and 1980s? Or is it experi- encing longer-run bouts of cyclical unemployment than in those decades? A better encing longer-run bouts of cyclical unemployment than in those decades? A better understanding of the determinants of job creation in the aftermath of recession understanding of the determinants of job creation in the aftermath of recession is crucial for improving the empirical analysis of equilibrium models of frictional is crucial for improving the empirical analysis of equilibrium models of frictional unemployment, and it also holds promise for improving labor market policies unemployment, and it also holds promise for improving labor market policies aimed at combating jobless recoveries.aimed at combating jobless recoveries.

■ The authors are grateful to Glenn Rudebusch and John Williams for their suggestions and comments. The views expressed in this paper are solely those of the authors and are not attributable to the Federal Reserve Banks of New York and San Francisco or the Federal Reserve System.

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