Supporting Price Stability

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October 09, 2012

Supporting Price Stability

All of the five questions that Chairman Ben Bernanke addressed in his October 1 speech to the Economic Club of Indiana rank high on the list of most frequently asked questions I encounter in my own travels about the Southeast. But if I had to choose a number one question, on the scale of intensity if not frequency, it would probably be this one: "What is the risk that the Fed's accommodative monetary policy will lead to inflation?"

The Chairman gave a fine answer, of course, and I hope it is especially noted that Mr. Bernanke was not dismissive that risks do exist:

"I'm confident that we have the necessary tools to withdraw policy accommodation when needed, and that we can do so in a way that allows us to shrink our balance sheet in a deliberate and orderly way. ...

"Of course, having effective tools is one thing; using them in a timely way, neither too early nor too late, is another. Determining precisely the right time to 'take away the punch bowl' is always a challenge for central bankers, but that is true whether they are using traditional or nontraditional policy tools. I can assure you that my colleagues and I will carefully consider how best to foster both of our mandated objectives, maximum employment and price stability, when the time comes to make these decisions."

While the world waits for "take away the punch bowl" time to arrive, here is another question that I think worthy of consideration: "Looking back over the past several years, what is the risk that the Fed's price stability mandate would have been compromised absent accommodative monetary policy?"

As the Chairman noted in his speech, it isn't easy to take the evidence at hand and argue any inconsistency between the Federal Open Market Committee's (FOMC) policy actions and its price stability mandate:

"I will start by pointing out that the Federal Reserve's price stability record is excellent, and we are fully committed to maintaining it. Inflation has averaged close to 2 percent per year for several decades, and that's about where it is today. In particular, the low interest rate policies the Fed has been following for about five years now have not led to increased inflation. Moreover, according to a variety of measures, the public's expectations of inflation over the long run remain quite stable within the range that they have been for many years."

To the question I posed earlier, I am tempted to take those observations one step further. Without the policy steps taken by the FOMC over the past several years, the "excellent" price stability record would indeed have been compromised.

Consider the so-called five-year/five-year-forward breakeven inflation rate, a closely monitored market-based measure of longer-term inflation expectations. If you are not completely familiar with this statistic'and you can skip this paragraph if you are'think about buying a Treasury security five years from now that will mature five years after you buy it. When you make such a purchase, you are going to care about the rate of inflation that prevails between a period that spans from five years from today (when you buy the security) through 10 years from today (when the asset matures and pays off). By comparing the difference between the yield on a Treasury security that provides some insurance against inflation and one that does not, we can estimate what the people buying these securities believe about future inflation. The reason is that, if the two securities are otherwise similar, you would only buy the security that does not provide inflation insurance if the interest rate you get is high enough relative to inflation-protected security to compensate you for the inflation that you expect over the five years that you hold the asset. In other words, the difference in the interest rates across an inflation-protected Treasury and a plain-vanilla Treasury that does not provide protection should mainly reflect the market's expected rate of inflation.

When you look at a chart of these market-based inflation expectations along with the general timing of the FOMC's policy actions, from the first large-scale asset purchase in 2008'2009 (QE1) to the second asset purchase program (QE2) in 2010 to the maturity extension program (Operation Twist) in 2011, the relationship between monetary policy and inflation expectations is pretty clear:

In each case, policy actions were generally taken in periods when the momentum of inflation expectations was discernibly downward. A simple-minded conclusion is that FOMC actions have been consistent with holding the bottom on inflation expectations. A bolder conclusion would be that as inflation expectations go, so eventually goes inflation and, had these monetary policy actions not been taken, the Fed's price stability objectives would have been jeopardized.

Statements like this do not come without caveats. A perfectly clean measure of inflation expectations requires that Treasuries that do and do not carry inflation protection really are otherwise identical. If that is not the case, differences in rates on the two types of assets can be driven by changes in things like market liquidity, and not changes in inflation expectations. Calculations of five-year/five-year-forward breakeven rates attempt to control for some of these non-inflation differences, but certainly only do so imperfectly.

Perhaps more pertinent to the current policy discussion, inflation expectations have, in fact, moved up following the latest policy action'which I guess people are destined to call QE3. But unlike the periods around QE1, QE2, and Twist, QE3 was not preceded by a period of generally falling longer-term breakeven inflation rates. So this time around there will be another, and perhaps more challenging, chance to test the proposition that monetary accommodation is consistent with price stability. As for previous actions, however, I'm pretty comfortable arguing the case that the price stability mandate was not only consistent with accommodation, it actually required it.

By Dave Altig, executive vice president and research director at the Atlanta Fed

 

October 9, 2012 in Monetary Policy | Permalink

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Trends in Small Business Lending

« How Big Is the Output Gap? More Perspectives from Our Business Inflation Expectations Survey | Main

October 03, 2012

Trends in Small Business Lending

The Atlanta Fed's latest semiannual Small Business Survey is active through October 22, 2012. If you own a small business and would like to participate, send an e-mail to SmallBusinessResearch@atl.frb.org.

In our previous survey conducted in April 2012, we found that firms applying for credit at large national banks had notably less success than firms that applied to small banks.

We also found that the firms applying to large banks tended to be much younger than the firms that applied to small banks. We speculated that this "age factor" could be contributing to the lower overall success rates at large banks.

A difference between small businesses' success at large and small banks has also been documented by the online credit facilitator Biz2Credit. Biz2Credit works a bit like an online dating service'after answering a series of questions (and providing the typical financial documents required by lenders), small businesses are presented with five potential "matches." To determine the best five matches, Biz2Credit identifies what lenders are looking for'usually a certain credit score, a minimum number of years in business, an established banking relationship, and targeted industries.

The resulting credit applications are the basis for the Biz2Credit Small Business Lending Index. Biz2Credit also reports approval rates from the matching process for large banks, small banks, credit unions, and alternative lenders. These approval rates are plotted on the chart below.

Much like we saw in the Small Business Survey, Biz2Credit reports that small firms have had consistently less success in obtaining credit at large banks.
Confirming our results encourages us that our April observation was a good one. But confirmation isn't explanation'what accounts for the different experiences small businesses have in securing credit from small banks versus big banks? And so, we dig deeper.

Note: According to Biz2Credit, its index is based on 1,000 of the 10,000-plus applications submitted each month. To be included, the business has to have at least a 680 credit score, be at least two years old, and have an established relationship with the bank to which it is applying. Selection methods are also applied to provide for national representation.

By Ellyn Terry, senior economic research analyst at the Atlanta Fed

October 3, 2012 in Banking, Small Business | Permalink

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How Big Is the Output Gap? More Perspectives from Our Business Inflation Expectations Survey

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September 27, 2012

How Big Is the Output Gap? More Perspectives from Our Business Inflation Expectations Survey

Opinions vary widely about how much slack there is in the economy these days. Some say a lot'some say not so much.

Last month, we reached out to members of our Business Inflation Expectations (BIE) panel for their take on the issue. The panel indicated they had more pricing power in August than they did last October. OK, that doesn't exactly gauge the amount of slack businesses think they have, but it does suggest that, however much slack there is, it's been shrinking.

Another detail revealed by our August inquiry was that retailers think they have more pricing power compared with manufacturers'a pretty good sign the latter is experiencing more slack than the former.

In this month's BIE survey we went fishing in the same murky waters, but this time we took a more direct approach. We asked our panel to provide a percentage estimate of how far their sales levels are above/below "normal." Here's what we found: On a gross domestic product (GDP)'weighted basis, the panel estimates that current sales are about 7.5 percent below normal. That's more slack than the conventional estimates, like the Congressional Budget Office's (CBO) measure of the GDP gap, which puts the economy about 6 percent under its potential.

But perhaps a more interesting observation from our September survey is how widely current performance varies by sector and size within our panel. Retailers, for example, say their current sales are a little less than 2 percent below normal. And firms in the leisure/hospitality and the transportation/warehousing sectors'sectors where growth has been particularly robust in recent years'say they are operating at, or just a shade above, normal levels.

Compare these estimates with those from durable goods manufacturers, which report that their current sales levels are nearly 12 percent below normal, and finance and insurance companies, which say they are almost 17 percent below normal. And construction firms? Well, best not even ask them.

And the amount of slack firms are reporting isn't just a reflection of their sector of the economy'size also matters. Firms with more than 500 employees say their current sales levels are a little less than 5 percent below normal'half as much as the amount of slack being reported by small firms.

So we're led back to the question that kicked this blog post off. How big is the output gap? Some say a lot'some say not so much. And this difference in perspective is not just among policymakers. Within the economy, experience varies at least as widely; some firms' sales are still well below normal, while others are telling us that they are very nearly back to normal, and some are already there.

But here's the rub. If the economy represents a constellation of firms operating at widely varying levels of capacity, from what viewpoint should we consider the economy relative to its potential? Are aggregate measures, like the one provided by the CBO or by our "GDP-weighted" approach, appropriate perspectives? Indeed, given widely varying measures of economic performance across firms and industries, how meaningful is an aggregate assessment of economic slack?

Ah, we'll leave these questions for the November survey.

By Mike Bryan, vice president and senior economist,

Laurel Graefe, economic policy analysis specialist, and

Nicholas Parker, economic research analyst, all with the Atlanta Fed

 

September 27, 2012 in Inflation, Inflation Expectations | Permalink

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Scientists? Engineers? How about Gardeners?

« Examining the Recession's Effects on Labor Markets | Main | How Big Is the Output Gap? More Perspectives from Our Business Inflation Expectations Survey »

September 27, 2012

Scientists? Engineers? How about Gardeners?

In the past few days Simon Wren-Lewis (at Mainly Macro) and Noah Smith (at Noahpinion) have revisited some past musings by Greg Mankiw on whether we should think of macroeconomists as scientists or engineers. The separation between the two in Mankiw's telling occurs at the point where macroeconomics meets policy'when macroeconomists leave the academic cloister and take up the causes of the real world. In Mankiw's original words:

God put macroeconomists on earth not to propose and test elegant theories but to solve practical problems.

Wren-Lewis and Smith each have their own issues with the scientist/engineer taxonomy, but both seem to more or less buy into the notion of macroeconomist cum policymaker as an engineer.

For my part, I'm not a fan of the engineer metaphor. It seems a little'well, immodest. Consider these comments, to take just a select few, from Federal Reserve officials following the decision of the most recent Federal Open Market Committee (FOMC) meeting. First, from Fed Chairman Ben Bernanke (via Econbrowser):

The policies that we have undertaken have had real benefits for the economy in that they have provided some support, that they have eased financial conditions and helped reduce unemployment. All that being said, monetary policy, as I've said many times, is not a panacea, it is not by itself able to solve these problems. We are looking for policymakers in other areas to do their part. We will do our part and we will try to make sure that unemployment moves in the right direction, but we can't solve this problem by ourselves.

And this, from a September 18 speech by Chicago Fed President Charles Evans:

Given the slow and fragile recovery, the large resource gaps that still exist, and the large risks we face, it remains clear that we needed a more resilient economy that can withstand the headwinds that might come its way. Last week the FOMC provided a more accommodative monetary policy that can help us achieve such resilience.

Or this, from a September 21 speech by Atlanta Fed President Dennis Lockhart:

The core rationale of my support [for the FOMC decision] was to better assure that the economy remains on a growth trajectory sufficient to steadily, if gradually, reduce the rate of national joblessness. I am not expecting miracles.

I think the action recently taken by the committee has improved the country's economic prospects by reducing the potential downside apparent in the incoming data. In this sense, the policy action was a preventative. But I expect policy will do more than just prevent backsliding.

To be sure, each of the three express confidence that the FOMC's actions will yield better outcomes than would otherwise occur. I guess you could say 'engineer' better outcomes, if you like. But I am struck by some of the other ideas expressed in these comments, related to reducing downside potential, promoting resilience, and providing some support.

I credit my colleague Mike Bryan (who credits former Cleveland Fed President Jerry Jordan, our mutual former boss) for suggesting that these types of motivations are better associated with gardening than engineering science. The good gardener does not presume to create growth, but knows that he or she can play a part by ensuring that growing conditions are the best that they can be. The gardener cannot make the sun shine by applying scientific knowledge, but can take measures to promote resilience and support until it does.

Science and engineering are important, without doubt. But when it comes to policymakers, I'll take a green thumb any day.

By Dave Altig, executive vice president and research director at the Atlanta Fed

September 27, 2012 in Federal Reserve and Monetary Policy | Permalink

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I am sorry. But when I think about the economy as a garden, I immediately think of
Peter Sellers as Chance the Gardener ( Chauncey Gardener) in the film of Being There
-- which was released in 1979.

Posted by: malcolm | September 28, 2012 at 02:07 AM

Examining the Recession's Effects on Labor Markets

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September 20, 2012

Examining the Recession's Effects on Labor Markets

Four years after the onset of the Great Recession, labor market outcomes in the U.S. remain depressed. The fraction of 16- to 64-year-old individuals who are employed fell from above 72 percent in 2007 to less than 67 percent in 2009 and remains stuck there. The unemployment rate rose from 4.5 percent to 10 percent and still hovers above 8 percent. And the fraction of unemployed workers who have been looking for a job for more than six months has increased to a share not seen in the United States in at least 60 years. The Atlanta Fed's Center for Human Capital Studies hosted a conference last weekend, organized by Richard Rogerson (Princeton University), Robert Shimer (University of Chicago) and the Atlanta Fed's Melinda Pitts that explored why the employment losses were so large and why the labor market recovery has been so weak. Examining these questions is important because different hypotheses about the nature of the recession suggest that different policy interventions may help to accelerate the recovery.

The paper "On the Importance of the Participation Margin for Labor Market Fluctuations" by Michael Elsby, Bart Hobijn, and Ay'egül 'ahin offered some suggestions on how to think about the disparate behavior of the unemployment rate and labor force participation rate during the last couple of years. While the unemployment rate has steadily fallen back towards its historic levels, labor force participation has fallen, keeping the employment-population ratio constant. At some level, this movement suggests that the decline in labor force participation has acted as a relief valve for the unemployment rate. Using evidence on the gross flows of workers between employment, unemployment, and out-of-the-labor-force, Elsby and his coauthors question that interpretation. Instead, relatively few unemployed workers have dropped out of the labor force during the recovery, reflecting the high desire to work among the current stock of unemployed individuals.

A number of papers offered specific hypotheses about the reason for the large and persistent deterioration in labor market outcomes and tested those hypotheses using a variety of methodologies and datasets. For example, the paper "What Explains High Unemployment? The Aggregate Demand Channel" by Atif Mian and Amir Sufi explored the implications of the negative shock to household balance sheets that followed the collapse in house prices. They document that employment in the nonconstruction, nontraded sector declined most in U.S. counties that experienced the largest adverse shock to house prices, while the decline in the traded goods sector occurred equally nationwide. If wages and prices were flexible, we would expect the balance sheet shock to reduce the demand for nontraded goods and raise the supply of labor and hence employment in the traded good sector. The fact that this did not happen is evidence that wages and prices have not adjusted. They infer that roughly two-thirds of the total employment losses can be attributed to the balance sheet shock, in combination with wage and price rigidities.

A second hypothesis is that the recovery has been so weak because of underlying adverse trends in the U.S. labor market. "Manufacturing Busts, Housing Booms, and Declining Employment: A Structural Explanation" by Erik Hurst, Matt Notowidigdo, and Kerwin Charles shows how the ongoing decline in the demand for less educated men in manufacturing has generated a negative trend in labor market outcomes for these workers for three decades. This trend continued unabated during the years after the 2001 recession but was masked by the housing boom, which lifted employment for less-skilled workers for another five years. This observation is relevant for how one interprets the time series changes in labor market outcomes. If we view the housing boom as an aberration that is unlikely to resume, it is inappropriate to compare current labor market outcomes with those just preceding the onset of the Great Recession.

The paper "The Trend is the Cycle: Job Polarization and Jobless Recoveries" by Nir Jaimovich and Henry Siu focuses on a related but distinct long-term phenomenon in the U.S. labor market: job polarization. This refers to the fact that the U.S. labor market increasingly consists of low- and high-paying jobs with relatively few middle-income jobs. While this ongoing change has been noted by other researchers, Jaimovich and Siu show that this long-term evolution has not been occurring at a slow and steady rate but rather has been concentrated during aggregate downturns. They argue that the recent phenomenon of jobless recoveries is simply a reflection of the fact that these are the periods in which middle income jobs are disappearing, never to be brought back.

On the other hand, "The Labor Market Four Years Into the Crisis: Assessing Structural Explanations" by Jesse Rothstein explores and finds little direct evidence for a number of specific structural channels that might explain the weak recovery. For example, there are no identifiable sectors of the U.S. economy with strong wage growth, which suggests that the shortage of suitable workers is probably not a large constraint on employment growth.

A third hypothesis is that the weak recovery reflects an increase in economic uncertainty, which induces firms to wait rather than hire and invest. "Measuring Economic Policy Uncertainty" by Scott Baker, Nicholas Bloom, and Steve Davis proposes a novel methodology for quantifying the overall level of economic uncertainty and the portion of uncertainty that is induced by economic policy. They show that both measures of uncertainty have been elevated since the onset of the Great Recession and have scarcely recovered during recent years. "Uncertainty, Productivity and Unemployment in the Great Recession" by Edouard Schaal examines how an increase in uncertainty affects labor market outcomes in the context of a job search model. He focuses on one measure of uncertainty, the cross-sectional variability of sales growth rates across business establishments, which increased sharply in 2008 but has since subsided. Because of this finding, Schaal finds that the model can account for a large deterioration in labor market outcomes at the time of the shock but that it cannot explain why the deterioration has been so persistent.

A final hypothesis is that the weak recovery reflects disincentive effects of new tax and transfer programs that have been introduced since the onset of the recession. One aspect of this that has attracted particular attention is the extension of unemployment benefits. "The Effect of Unemployment Insurance Extensions on Reemployment Wages" by Johannes Schmieder, Till von Wachter, and Stefan Bender uses evidence from Germany to explore this hypothesis. They show that extending unemployment benefits by six months causes approximately a one-month increase in the amount of time it takes an individual to return to work. This extension has two effects on the wage of workers when they return to work. On the one hand, the additional time to look for a job allows workers to find better jobs. On the other hand, workers' skills tend to decline during an unemployment spell. On net, these effects roughly cancel so extended benefit programs do not have a large impact on average wages.

The framework that most economists use to study the behavior of unemployed workers is search theory. Robert Hall's paper "Viewing the Observed Acceptance Decisions of Job-Seekers through the Lens of Search Theory" analyzes detailed data on the job finding process for a sample of unemployed workers in New Jersey from 2009 in the context of this theory to assess how well the theory can provide a consistent explanation for observed behavior. Previous work had suggested that this framework has problems in accounting for observed job acceptance decisions, but Hall shows that with a few simple modifications, the framework offers a consistent explanation of how workers behave given labor market conditions.

The discussions at the conference questioned the usefulness of labels like deficient demand, structural unemployment, and cyclical unemployment. These terms mean different things in different contexts and do not clarify the key causal factors. Explanations such as "employment is slow because uncertainty is high" could easily fit under any of these banners. Instead, isolating the key changes that have taken place in the U.S. economy, and then scrutinizing the factors that have influenced how those changes have affected the labor market, would be more conducive to arriving at answers.

By Melinda Pitts, a research economist and associate policy adviser in the Atlanta Fed's research department

September 20, 2012 in Labor Markets | Permalink

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Will the Housing Market Recovery Leave the Hardest-Hit Neighborhoods Behind?

« The Decline in Unemployment: Any Silver Lining? | Main

September 17, 2012

Will the Housing Market Recovery Leave the Hardest-Hit Neighborhoods Behind?

The national news about residential real estate has been rosy. The latest figures from the U.S. Census Bureau and HUD find that sales of new single-family houses in July 2012 were up 3.6 percent over the June rate, and 25.3 percent above July 2011 numbers. The National Association of Realtors reported that existing-home sales grew 2.3 percent to a seasonally adjusted annual rate of 4.47 million in July from 4.37 million in June and are 10.4 percent above the July 2011 pace. The June S&P/Case-Shiller report on housing prices showed positive monthly gains across all markets in its 20-city composite for the second month in a row.

However, a large number of homes remain in the foreclosure pipeline and many of these properties are concentrated in certain neighborhoods, which is a particular challenge for recovery in these areas because research suggests that concentrated mortgage delinquency and foreclosure can depress housing prices (see discussions here, here, and here).

To examine this issue and the barriers to recovery in areas heavily affected by foreclosure, the Federal Reserve Bank of Atlanta's Community and Economic Development (CED) group conducted a poll to explore housing market conditions in the Southeast. We asked Neighborhood Stabilization Program administrators, HUD-approved housing counselors, and real estate brokers across the Sixth Federal Reserve District about price expectations and changes in supply and demand in the housing market. The poll was administered between August 7 and August 24. We received 224 responses to the poll and conducted an additional 23 interviews, all within the Sixth District, which includes all of Alabama, Florida, and Georgia, and parts of Louisiana, Mississippi, and Tennessee. The overall response rate to the poll was 30 percent (individual state response rates varied from 22 percent (Georgia) to 52 percent (Tennessee).

When we asked about their house price expectations over the next year (see the chart), we saw signs of bifurcation, with more than half (54 percent) expecting the overall jurisdiction to experience gains, but nearly half (48 percent) expecting the hardest-hit areas in those jurisdictions to continue to see price declines. (For our purposes, "hardest-hit areas" are defined as the top 10 neighborhoods in the area that had the most foreclosures. Also the differences across all parameters'price, inventory of homes for sale, and interest in home buying'between overall jurisdiction and the hard-hit areas are statistically significant.)

The differences between the overall jurisdiction and the hard-hit areas are less pronounced, though still present, when we asked respondents about changes in home buying interest and the number of homes for sale in the last six months (see the chart). Reflecting on the overall jurisdiction, 67 percent said that interest in home buying increased, and of those only 14 percent said it was a significant increase. Another 17 percent experienced decreased home-buying interest.

The "home-buying enthusiasm" found in overall jurisdictions is not as robust when respondents talked about hardest-hit neighborhoods. Although 46 percent mention that the interest in home buying in these areas has increased, it was offset by the 29 percent who noted a decrease in interest in home buying in these areas.

On the other hand, the inventory of homes for sale in the overall jurisdiction has increased in the last six months, according to 57 percent of the respondents (see the chart). (Of these respondents, 45 percent said the inventory increased modestly.) When referring to hardest-hit areas, almost half said that the number of homes for sale had increased in the last six months, 26 percent said it had remained the same, and 27 percent said the number had decreased. And while the trends in the overall jurisdiction and the hard-hit areas may not be wildly divergent in terms of the for-sale inventory, the causes may be different. In the overall jurisdiction, homeowners may be putting their homes on the market because they feel better about the potential returns, whereas it seems reasonable to suggest that in hard-hit areas the increase in inventory of homes for sale may reflect a continued foreclosure pipeline.

We then asked about the top barriers to house-price stabilization and recovery in the areas hardest hit by foreclosure. According to our respondents, the most significant barrier is the poor credit scores and financial history of people wanting to purchase homes in these areas (see the table). With tightened lending standards, fewer people are able to secure financing to buy homes. The next two barriers concern the continued flow of foreclosure starts in these areas. In these cases, the respondents suggest that foreclosures are initiated either because people owe more on their homes than they are worth or because of recent unemployment or underemployment of borrowers decreasing the ability to repay. Respondents also noted that low appraisals in hard-hit areas have undermined sales. Finally, the high concentration of vacant properties, likely perpetuated by the higher-ranked barriers identified in the poll, presents an image of disinvestment in the areas, making it difficult to attract new buyers.

It's important to recognize that even among hard-hit areas there are notable variations and expectations for the future. For example, responses to house price expectations in Florida's hard-hit areas were much more optimistic, with 36 percent expecting increases in the next year, compared to Georgia's hard-hit areas, where only 3 percent anticipated prices going up. Of course, there are metro areas where this "micro-recovery thesis," as Nick Timiraos of the Wall Street Journal puts it, is not at play. "Denver and Phoenix are experiencing price increases in almost every ZIP code," he notes. (A previous macroblog post provides another look at ZIP code'level house price analysis.)

By Karen Leone de Nie, research manager in the Atlanta Fed's Community and Economic Development (CED) department,

 

and

Myriam Quispe-Agnoli, an Atlanta Fed research economist and adviser to the CED research and policy team

September 17, 2012 in Housing | Permalink

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The Decline in Unemployment: Any Silver Lining?

« Rising House Prices: The Good Fortune Spreads | Main

September 11, 2012

The Decline in Unemployment: Any Silver Lining?

Among the somewhat dreary jobs reported released last Friday, there was one potential bright spot'the unemployment rate declined from 8.25 percent in July to 8.11 percent in August. Of course, determining whether this is a true bright spot requires delving further into the numbers, and the determination depends on what happened to those people once they were no longer counted among the jobless. Did they get jobs? Some did, but an unusually large number of them simply left the labor force'the labor force participation rate hit a new post-1980 low, leaving some doubt about whether the cloudy employment report had any silver lining at all.

To detail the situation, the unemployment rate dropped from 8.25 percent in July to 8.11 percent in August, driven by a 250,000-person drop in the number of unemployed between July and August (a 1.95 percent drop). This is the largest decline in the number of unemployed since January 2011 and almost 2.5 times larger than the average monthly decline seen from July 2011 to July 2012 (103,500).

Where did those formerly unemployed people go? To get at this issue, I went to the Current Population Survey (or CPS, from whence the unemployment statistics come) to examine the flows of people into and out of the labor force, and into and out of employment and unemployment. From July to August, the CPS data in the chart below reveal that approximately 60 percent of the unemployed remained in unemployment (blue line). Of the remaining 40 percent, over half (54 percent) of the unemployed flowed out of the labor force in August (red line) while the other 46 percent (green line) flowed into employment.

It is interesting to note that the share of exits to employment fell below the exits out of the labor force for the first time in the last few months of 2008 and has remained so throughout the recovery.

Although the share exiting the labor force from unemployment has not increased, the number of individuals leaving unemployment because they leave the labor force has been on the rise since May, as the chart below shows:

This increase in the number of individuals exiting the labor force from unemployment, of course, leads to obvious concerns that lower unemployment may be a result of a rise in the number of workers who have simply become too discouraged to continue seeking employment. As financial writer Mark Gongloff points out:

The majority's reaction to these numbers on Friday was that they were an awful sign, that the job market is so bad that hundreds of thousands of people every month are simply giving up in despair. We have growing numbers of people sitting around doing nothing, losing their job skills and their ability to buy stuff.

Perhaps that's a bit too pessimistic. The U.S. Bureau of Labor Statistics (BLS) does track people who have dropped out of the labor force but who have looked for work sometime in the last 12 months and report that they are available work. The BLS also asks these individuals'referred to as the "marginally attached"'if they consider themselves as having left the job-search process because they are discouraged.

To begin with, it is important to realize the scale of the problem: the number of discouraged, marginally attached people corresponds to less than 7 percent of the unemployed and approximately 1 percent of those not in the labor force. More importantly, we can see from the reported data in the chart below that the share has been on a downward trend and is now close to prerecession levels.

If the share of nonparticipants who indicate they want to work but are discouraged is declining and relatively small, what about other nonparticipants? It's a good question, and in a previous macroblog post my coauthor Julie Hotchkiss discussed research presented in an Atlanta Fed FRBA working paper (coauthored with Fernando Rios-Avila) that attempts to get to this question.

First, we found that approximately 70 percent of those under age 25 indicate that the reason they are not in the labor force is because they are in school, a rate that has not changed with the rather dramatic decline in participation seen in the last decade and during the recession and recovery.

In prime working age'the cohort 25 to 54 years old'household care is the dominant reason individuals indicate they are out of the labor force. But in terms of changes in the numbers of people out of the labor force in this age group, we found significant increases only for the shares who indicated they were out of the labor force for schooling and for "other," or unspecified, reasons.

As Julie concluded in her earlier post, for those in school, the expectation is that they are accumulating skills and they will enter/reenter the labor force with higher levels of human capital. While there could be some concern over atrophy of skill for those individuals in the "other" category, the evidence suggests that for a large share of these individuals, the nonparticipation is not permanent, as roughly 45 percent of individuals in that category transition back into the labor force within a year'a rate that is increasing during the recovery.

A small ray of hope, perhaps, but hope nonetheless.

By Melinda Pitts, a research economist and associate policy adviser in the Atlanta Fed's research department

September 11, 2012 in Employment | Permalink

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