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What happens to unemployment rates after a recession?

Patty Silverstein

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Written by Patty Silverstein, chief economist for the Metro Denver EDC, this
section identifies major issues affecting the economy and answers frequently asked
questions.

Economists are predicting increasing unemployment and a rising unemployment rate into
2010 despite forecasting the recession to end sometime in the last half of 2009. Is this a
paradox? Intuitively, it seems that if an economy is expanding then businesses will be
hiring and the rate of unemployment should drop. However, looking back on the
recession ending in 2001, it took 19 months for the national unemployment rate to peak
and then decrease after the expansion started.

Many sources project that the trend for the current recession will be no different with
unemployment rates peaking after the trough of the business cycle. For instance,
Chairman of the Federal Reserve Board of Governors Ben S. Bernanke, in a recent
testimony to the House Budget Committee, projected that the recession would end by the
end of this year. Yet he also states that unemployment “is likely to rise for a time, even
after economic growth resumes.” In order to analyze this phenomenon, here are a few
questions and answers to explore the unemployment rate, recessionary trends, and their
relationship to each other.

Q: Does the unemployment rate historically continue to increase after the end of a
recession?

The official declaration of a business cycle contraction, or recession, comes from the
National Bureau of Economic Research (NBER). The NBER is a private, non-profit
research organization founded in 1920.
Since December of 1969, the NBER has
identified seven U.S. recessions. The current
recession officially started in December
2007 and the NBER has not yet declared an
end to this downturn.
Based on the NBER business cycles and seasonally adjusted national unemployment rate
data from the U.S. Bureau of Labor Statistics, the unemployment rate has increased and
peaked after the end of the prior six recessions in the U.S. The length of time between
the end of a recession and the peak in unemployment varies with each recession and
appears to be increasing over time. Indeed, after the 2001 recession we often heard
economists refer to the economic situation as a “jobless recovery.”

Q: Why does the unemployment rate continue to rise after the end of a recession?

There are a number of reasons that the unemployment rate continues to rise after the
trough of a recession. The least complex reason is the methodology the NBER uses to
determine the end of economic contractions and the start of economic expansions.
According to the NBER, unemployment is only one of several indicators used to identify
when a contraction ends and an expansion begins. In determining a recessionary trough,
the NBER gives more weight to the growth in national gross domestic product and
productivity. Productivity growth tends to precede growth in employment. According to
the NBER’s announcement of an economic expansion beginning in November 2001,
“The NBER defines expansions and recessions in terms of whether aggregate economic
activity is rising or falling, and it views real
GDP as the single best measure of economic
activity. Real GDP has risen since November
2001. However, this growth in real GDP has
resulted entirely from productivity growth. As
a result, the growth in real GDP has been
accompanied by falling employment.
Unemployment has risen because of falling
employment and because the labor force has
been rising.” Indeed, employers often
continue to shed jobs even after the official end of a recession. The chart below shows
that over-the-year growth in total non-farm employment continued to be negative after
the last six recessions ended.

Other reasons are as follows:

• The labor force may grow despite economic expansions or contractions. The labor
force is defined by the U.S. Bureau of Labor Statistics as the civilian population
over the age of 16 years old who are either employed or who want to work and
are actively seeking employment (the unemployed). When the labor force grows
while businesses are shedding jobs or are reluctant to hire, the unemployment rate
increases.

Sources of growth are re-entrants to the labor force and new entrants to the labor
force. While the number of new entrants to the labor force mainly follows
demographic changes, re-entrants to the labor force after a recessionary trough
could be formally discouraged workers who, upon seeing economic conditions
improve, decide to actively seek employment again.
• Employers continue to shed jobs in order to cut costs. Job losers and other
workers who have completed temporary jobs are the biggest component of the
unemployed labor force during a recession. As the chart above shows, over-the-
year growth in employment continues to be negative even after the official end of
a recession, although it is declining at a decreasing rate.

• Employers remain reluctant to hire new workers. The trend for employers to be
reluctant to hire following a recession is evident even at a local level. The
Manpower Employment Outlook Survey published by Manpower, Inc. tracks the
percent of companies hiring, laying off, maintaining current employment levels,
or are unsure. In 2001, the percent of companies in the Denver area who were
hiring dropped to 15 percent in third quarter 2003 from 26 percent in third quarter
2001. Concurrently, the percent of companies who were laying off rose to 20
percent in third quarter 2003 from 9 percent in third quarter 2001. The percent of
companies either laying off, maintaining current employment levels, or were
unsure rose from 74 percent to 85 percent over the same time period. Employers
tend to wait for uncertainty to clear and markets to improve before they make
significant hiring decisions. This reality is evident in the current recession as well.
Since fourth quarter 2007 when the recession started, the percent of companies
who are unsure whether they will hire or lay off has risen from 52 percent to 73
percent in the second quarter 2009.

Q: Once a recession ends, how long does it take before the unemployment rate begins
to drop?

The time it takes for the employment rate to peak after the end of a recession varies
widely. While an unemployment peak after a recession appears to be a trend, the timing
depends on when the NBER declares a trough in the business cycle. The NBER also
reserves the right to revise the business cycle data as it sees fit. Current data on the
recession ending in November 1975 indicates that the unemployment rate peaked just two
months after the recession ended. However, the unemployment rate did not peak for 19
months following the end of the 2001 recession. The length of time between the end of a
recession and peak unemployment has increased over the last few recessions. This may
be a result of increases in productivity that do not necessarily correlate with employment
levels. The NBER also considers increases in other output-related indicators such as
personal income, industrial production, and sales that may also precede a decrease in
unemployment.

Q: Why might an increase in economic activity precede a decrease in the


unemployment rate?

To reiterate, the NBER places more emphasis on output-related measures such as GDP,
personal income, industrial production, and sales, than on labor-related indicators like the
unemployment rate. When an economic contraction is slowing and an expansion is
beginning, employers might be able to bring idled factory capacity back online without
significant numbers of new employees. Businesses may also increase the number of
hours worked before they hire new workers to fill open positions. Another possibility is
employers defer recessionary responses like mandatory time-off and bring back
furloughed workers before they hire again. These decisions would be in response to an
increase in sales and would raise personal incomes. While the decisions businesses make
in response to a recession are complex, the last few recessions seem to indicate that an
employment lag will continue to be the norm.