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Tuesday, November 1, 2011

Economic Growth and the Unemployment Rate

Linda Levine
Specialist in Labor Economics

A persistently high unemployment rate is of concern to Congress for a variety of reasons, including its negative consequences for the economic well-being of individuals and its impact on the federal budget (i.e., deficit growth due to lower revenue and higher expenditures). The unemployment rate was 9.5% when the economy emerged from the 11th postwar recession in June 2009, and it climbed further to a peak of 10.1% in October 2009. The unemployment rate very slowly declined in 2010. It settled at about 9.0% during the first three quarters of 2011.

The stalled rebound of the labor market has renewed calls for new measures to stimulate economic growth amid speculation about a double-dip recession, such as occurred during the early 1980s. The economy contracted in July 1981, just 12 months into the recovery from the January-July 1980 recession. The unemployment rate had not fallen to its pre-recession level before the 1981-1982 recession began.

After most postwar recessions, it took at least eight months for the unemployment rate to fall by one full percentage point. The slowest decline occurred after the expansion that ended in November 2001, when the unemployment rate was a comparatively low 5.5%. About 3½ years elapsed before the rate fell just one-half of one percentage point. In contrast, the recovery from the severe July 1981-November 1982 recession began with the highest unemployment rate of the postwar period (10.8%). In that instance, it took only eight months for the rate to fall more than one percentage point. Although some had hoped that the unemployment rate would fall as quickly after the Great Recession, the rate one year later was the same as at the outset of the recovery (9.5% in both June 2009 and 2010). The unemployment rate more than two years into the economic expansion is only about 0.5 percentage points lower than at its start.

What appears to matter for a reduction in the unemployment rate is the rate of actual economic growth compared with the rate of growth in potential output (i.e., the output gap). Potential output is a measure of the economy’s capacity to produce goods and services when resources, such as labor, are fully utilized. The rate of growth of potential output is a function of the growth rates of potential productivity and the labor supply when the economy is at full employment. If, as projected, potential output growth is about 2.3% annually, then the growth rate in real gross domestic product (GDP) would have to be greater to yield a declining unemployment rate. How much it is above that level will determine the speed with which the unemployment rate declines.

Although real GDP initially grew at a high rate, its pace slowed in the first three quarters of 2011. Improvement in the unemployment rate stalled as a result. The Congressional Budget Office (CBO) projects that the annual average growth rate of real GDP will not much exceed potential output until the 2013-2016 period. Unless the economy grows more strongly than currently projected, the unemployment rate is expected to remain close to 9.0% through 2013 before approaching its pre-recession level of 5.0% in 2016.

Date of Report: October 28, 2011
Number of Pages: 9
Order Number: R42063
Price: $19.95

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