Friday, March 7, 2014

February 2014 Labor Report Review & Beveridge Curve notes

Well, that's just about the way it usually goes.  I predicted a positive surprise, but I thought the report was slightly disappointing.  The market, however, appears to think it was a positive surprise.

Here are updates of a few indicators I've been watching.

Durations did not move in the direction I thought they would.  Long duration unemployment actually kicked up a beat last month.  I expect this to move strongly in the other direction over the next several months.  Of course, there is some noise in this data.

Next, is my estimate of the proportion of long-term unemployed workers who exit the unemployment category (more than 15 weeks) over a 3 month period.  This indicator had moved strongly higher over the last couple of months, but this month, it pulled back.  The trend should continue to move higher, though.

Next is the year-over-year change in average wages.  This continues to show strength.  Average wages are accelerating, even as inflation remains low.  This indicator is quickly entering territory that would normally be associated with rising interest rates.

Quits, Job Openings, and Unemployment

Finally, I want to address quits, job openings, and unemployment.  Scott Sumner linked to this post by Evan Soltas.  Evan's post includes this graph, comparing quits and unemployment.

If I understand Evan correctly, he's addressing observers who believe that labor markets are in worse shape than the unemployment rate would suggest.  He's saying that since there is a pretty stable relationship between quits and the unemployment rate, the unemployment rate is probably a decent indicator of slack in the labor market.

I think Evan should take it even further.  The unemployment rate is understating tightness in the labor market.  Pro-cyclical labor policies, especially the highly extended unemployment insurance (EUI) which has recently been retracted to normal levels, temporarily and significantly raised the natural unemployment rate by adding a sort of friction into the labor market that caused unemployed workers to re-enter employment more slowly.

The addition of employable workers to the roster of the unemployed caused both the quits rate to fall and the unemployment rate to rise, relative to where they would have moved in a typical business cycle.

The more accurate indicator of economic recovery in this context is the level of job openings.  That is why the Quits to Unemployment relationship remains stable - these measures are both being affected in proportionately similar fashion.  But, the Beveridge Curve did break down.  And, also I have a graph here, comparing quits to openings.

data are weighted moving averages to reduce noise.
The unemployment level was increased by this policy, which moved the Beveridge Curve to the right.  The Quits rate was decreased by this policy, which moved the Openings-Quits curve to the left.  Both of these shifts happened coincident with the implementation of EUI and the start of the labor crisis.  The shift remained in place for 5 years as employment recovered, and both relationships have now begun to shift back to the previous proportions, coincident with the end of EUI.

Note that job openings are back to where they were in 2005 while quits and the unemployment rate remain at or worse than the cycle trough of 2003, when the unemployment rate had topped out at 6%.  Wages are increasing at a rate similar to the rate of 2005 (see chart above).  Adjusted for consumer prices, wages are as strong as they were in 2006.  So wage growth corroborates the signal we are getting from job openings.

There are jobs available, but since unemployed workers have been incentivized to re-enter employment more slowly, these jobs remain unfilled.  Employed workers can't safely quit because qualified competition is on the sidelines, and employers aren't filling the jobs with less qualified available workers because potential workers are available, even if those workers aren't being as aggressive about taking the available jobs.

For an employer, it's like the situation an oil company would face if they had access to $60 oil in a $100 market, but they knew that there were countries with closed oil markets that had $40 oil in the ground.  As long as those countries had untapped potential reserves, oil supply development would fall somewhere below the level that would be predicted by markets with $100 oil.

(Please, as always, understand, that I am speaking of this in broad terms for narrative ease, but that all of these changes result from marginal subtle changes in behavior among many diverse and reasonable workers and employers.  I am not making some boogeyman out of unemployed EUI recipients.  And, we are talking about maybe 1% of the labor force.  These changes are very subtle.)

So, with the end of EUI, we will see the Beveridge Curve and the Openings vs. Quits relationships move back toward their normal levels.  We will see unemployment decline, to more accurately reflect the strong demand in the current labor market.  And, we will see a boost in real output resulting from the return to higher efficiency in the labor market.  In the last few months, coincident with the termination of EUI, we have already seen the beginning of this movement.


  1. Kevin,

    A few comments:

    (1) Unemployment insurance appears to have little effect on job finding rates, see Farber and Valletta (2013). The effect on the unemployment rate comes from labor-force dropouts -- but this merely presents the question of if we can expect labor-force dropouts to affect wage determination.

    (2) I'm very skeptical about your Beveridge curve analysis, for two reasons. For one, look up the paper by Davis, Faberman and Haltiwanger on "recruiting intensity." For another, look up the one by Rand Ghayad on long-term unemployment and the Beveridge curve. The former finds that those openings aren't "real" in the sense that employers are just sticking a line out to see if any highly qualified applicants bite -- they're not actively searching to fill the position; it's not absolutely necessary. The latter finds that when you just look at ST unemployment, there is no Beveridge curve shift. Both suggest that openings is a bad variable.

  2. Thanks for your response, and the references.

    Regarding (1), there are many studies that give a range of relationships, and some are much higher than the Farber Valletta study. Here is a study by David Grubb at OECD:

    Here's a GAO survey that shows behavior of workers who exhausted EUI. Less than 1/5 left the labor force. Also, they skew very old:

    Regarding (2), have you seen this report from the Boston Fed?

    It shows different behavior by age and reason for losing a job. For older workers, unemployment rates for job leavers have been normal, but unemployment rates for job losers (eligilble for EUI) have been high. This pattern is not clear in middle-aged workers, and reverses among younger workers (young job losers look normal, but job leavers, reentrants, and new entrants have higher unemployment).

    I would suggest that this bifurcated behavior of the disaggregated Beveridge Curve is a sign of the distortions from EUI, and regular looking ST unemployment together with high LT unemployment is exactly what we would expect to see if we thought EUI would distort labor markets.

    Also, the job opening behavior is what you would see in a labor market with less intense available labor supply, as described in my oil analogy above. If there are job openings available in jobs where highly qualified and experienced workers are available, but are being less aggressive about taking new employment due to a temporary policy, then we should expect employers to be less aggressive about filling jobs with applicants from the willing pool of workers - much like the oil driller would be ambivalent about drilling $60 oil in a $100 market when they know that $40 oil is being kept under the ground by political issues.

    If I was looking for evidence that the unemployment rate was overstating slack in the labor market caused in part by EUI, your evidence from point (2) is the kind of thing I would expect to find. (Although, I'm sure there are issues in the recruiting intensity paper that would challenge my interpretation. I haven't gone through the whole thing.)

    In fact, my broad estimate of the extra unemployment coming from EUI is based on comparing unemployment durations under 26 weeks with unemployment durations over 26 weeks. There has always been a very tight relationship between these measures, which broke down in the recent recession.