Is the US labor market doing better than we think?

February 4, 2014

What if the labor market America is actually much closer to a full recovery than we think? That’s the gist of a new post by Samuel Kapon and Joseph Tracy at the New York Federal Reserve. The authors examine the labor market’s employment-to-population ratio, which plummeted during the financial crisis and hasn’t recovered since, even as the economy has picked up steam.

Their general theory:  when corrected for the demographics of our aging workforce, the labor market looks a bit healthier than we previously thought. Here’s their chart:

Kapon and Tracy attempted to normalize the E/P ratio, adjusting for both cyclical employment trends and, crucially, for demographic trends like older people dropping out of the workforce. What they got was the blue line — which at the moment is pretty close to the actual E/P ratio (the red line).

Matthew Klein sees a few problems with the data, though. “The explanation ignores the actual data we have on employment by age group,” he writes, noting that aging alone can’t explain why America’s labor market has shrunk. Paul Krugman, too, is skeptical. He crunches the numbers on his own and finds that “around 40 percent of the decline is demographics, but the rest is cyclical, and that we’re still far below full employment.”

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