Daniel Sullivan

English

Research Papers in Economics

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK MARCH 1996
OF CHICAGO NUMBER 103
Chicago Fed Letter
Unemployment duration
and labor market tightness
Since the last recession, average un-
employment durations have been
surprisingly high given levels of other
labor market indicators.  Recently,
some have pointed to this as evidence
that there is more labor market slack
than is commonly believed.1  Their
argument is that the long-term unem-
ployed are willing to accept almost any
job, even jobs with reduced wages.
Thus, though there currently are
relatively few unemployed workers,
enough of them are sufficiently des-
perate that wage pressures are mini-
mal.  (A possible corollary is that
inflation concerns have been exagger-
ated and monetary policy has been
overly restrictive.)
However, one could also argue that
given any level of the unemployment
rate, higher average durations should
be associated with greater labor mar-
ket tightness.  This might be the case
if many of the long-term unemployed
lack the skills employers require and,
consequently, exert less restraint on
wages than the short-term unem-
ployed.  This Fed Letter examines these
arguments and offers some prelimi-
nary time-series evidence on the sig-
nificance of unemployment durations
for current inflationary pressures.
Unemployment durations
Unemployment statistics are derived
from the  Current Population Survey
(CPS), a monthly mini-census of
U.S. households.  Respondents aged
16 years and older are classified as
either employed, unemployed, or out
of the labor force.  The unemploy-
ment rate is the fraction of the labor
force that is unemployed and the
average unemployment duration is
the mean number of weeks the unem-
ployed have been looking for work.
Most unemployment spells are relative-
ly short, but an important minority are
quite long.  This skewness is reflected
in the median duration being consider-
ably shorter than the mean.  For exam-
ple, in December 1995 the mean dura-
tion was 16.2 weeks, but the median
duration was only 8.2 weeks.  Thus,
the majority of the unemployed were
looking for work significantly less than
16.2 weeks.  However, those experienc-
ing very long spells brought the mean
up to 16.2.
The fact that most unemployment
spells are short is evidence that the
labor market is more dynamic in
the U.S. than Europe, where long
spells are the norm.  Even in the
U.S., however, long spells account
for a significant portion of unem-
ployment.  For instance, in Decem-
ber 1995, 16.4% of the unemployed
had been out of work for more than
26 weeks.  (This is still low compared
with Europe, where typically more
than 60% have been unemployed
six months or more.)
The longer workers are unemployed,
the less likely they are to find work
in the next month.  There are two
possible reasons for this.  First, most
of those who can find work easily do
so quickly, leaving the remaining
pool of unemployed workers weight-
ed toward those facing special obs-
tacles.  Second, long-term unemploy-
ment may erode skills and demoral-
ize workers, causing them to take
even longer to find work.
Finally, it is worth noting that aver-
age duration is a mean calculated
over spells that are “in progress” at a
given date.  For two reasons, this
differs from the expected duration
of a completed spell.  First, most of
the unemployed will continue to be
unemployed after they have been
surveyed (which will not be account-
ed for in the calculation).  Second,
the calculation weights long spells
more heavily than short.  For in-
stance, a two-week spell will at most
be counted in the calculation one
month, while a 26-week spell could
be counted six months in a row.
This second effect is stronger, so that
a random worker becoming unem-
ployed in December 1995 will on
average find work in something clos-
er to 14 weeks.
Evolution over time
Figure 1 plots the unemployment
rate and average duration over the
last 30 years.  These series historically
have moved up and down together
over the business cycle, with average
durations lagging the unemployment
rate by a few months.  Since the un-
employment rate is itself a lagging
indicator, it is not surprising that
average unemployment duration is
one of the last economic indicators to
show improvement after a recession.
Durations have been abnormally high
relative to the unemployment rate
since at least the 1990–91 recession
(figure 1).  Durations were higher
during that recession than during the
1975 recession, even though the lat-
ter was much worse in terms of unem-
ployment.  Nearly five years after the
end of the last recession, average
durations remain near the highest
levels experienced during the 1975
recession, and are comparable to
those prevailing in December 1984
when the economy was barely two
years out of its worst postwar reces-
sion and the unemployment rate was
1.7 percentage points higher.
Figure 1 shows that average unem-
ployment durations recently have
been falling quite rapidly.  It is too
soon to tell, however, whether dura-
tions are returning to a more normal
level relative to unemployment.Longer-term trends also may have
played a role in increasing durations.
Indeed, if one looks closely at figure 1,
the trend towards longer durations is
visible well before 1990.  For instance,
while durations were substantially high-
er relative to unemployment following
the last recession than following the
1981–82 recession, they were also
somewhat higher relative to unemploy-
ment after the 1981–82 recession than
after the 1975 recession.
Juhn, Murphy, and Topel (1991) exam-
ined the trend towards higher male
unemployment from 1967 to 1989
using individual workers’ CPS records.2
They found that increasing unemploy-
ment durations, which began to appear
about 1970, accounted for much of
the increased unemployment over
the period.  They also found that the
increase in unemployment was most
pronounced at the low end of the skill
distribution.  For instance, unemploy-
ment in the lowest decile of the wage
distribution more than doubled, while
it was essentially unchanged for those
above the sixtieth percentile of the
wage distribution.
Juhn et al. interpreted the increase in
unemployment (as well as a parallel
increase in nonparticipation) for
workers with lower skills as a labor
supply response to an adverse shift in
the demand for their skills.  Consis-
tent with this interpretation, the real
wages of these workers declined pre-
cipitously over the 1970s and 1980s,
while those above the sixtieth per-
centile of the wage distribution had
approximately constant real wages.
Labor market tightness
The long unemployment durations
experienced by many workers may
represent an important economic
problem, especially if the root cause
is the failure of those workers to ob-
tain skills necessary for long-term
labor market success.  It is less clear,
however, what this phenomenon
implies about inflationary pressures.
The view that high durations imply
the labor market is less tight than
the unemployment rate would ordi-
narily suggest appears consistent with
the first two possible explanations
Figure 2 shows the flip side to high
unemployment durations.  That is, it
plots the total unemployment rate
along with the fraction of the labor
force unemployed one month or less.
The latter series also moves up and
down with the unemployment rate.
(In contrast to average duration,
though, it slightly leads unemploy-
ment over the business cycle.)  For the
last two years, the fraction of the labor
force newly unemployed has been as
low as anytime since the 1960s.
Underlying forces
During the last recession an unusually
high fraction of layoffs were perma-
nent rather than temporary.  Since the
transitions associated with permanent
layoffs are obviously more difficult,
this trend may have played a part in
the rise of average durations.
The last recession was also unusual
in that it was relatively severe for
white-collar workers, but relatively
mild for blue-collar workers.  This is
not to say that white-collar workers
had it worse than blue-collar work-
ers, just that blue-collar unemploy-
ment rates exceeded white-collar
rates by less than usual.  At any point
in time, white-collar workers are less
likely to be unemployed.  However,
perhaps because they have more
specialized skills, once unemployed
they typically take longer to find
appropriate reemployment.  Thus,
increased white-collar unemploy-
ment also may have contributed to
higher durations.
3
5
7
9
11
1967 ’71 ’75 ’79 ’83 ’87 ’91 ’95
7
11
15
19
23
percent weeks
Unemployment rate
(left scale)
Duration
(right scale)
Source: U.S. Department of Labor, Bureau of Labor Statistics, various releases.
Note: Shaded area indicates recession.
Source: U.S. Department of Labor, Bureau of Labor Statistics, various releases.
Unemployment rate
(left scale)
New
unemployment rate
(right scale)
3
5
7
9
11
1967 ’71 ’75 ’79 ’83 ’87 ’91 ’95
1.8
2.3
2.8
3.3
3.8
percent percent
Note: Shaded area indicates recession.
1. Unemployment rate and average unemployment duration
2. Unemployment rate and rate of new unemploymentwhite-collar workers, it may still be
that, given the level of the unemploy-
ment rate, high durations signal tight-
ness.  Both of these phenomena could
be signs that important structural
change is occurring.  Such change
should tend to raise the “natural rate”
of unemployment as workers are
forced to make difficult transitions
from one job to another.  Because
inflationary pressures should depend
on the gap between the natural rate
and actual unemployment, high dura-
tions would then signal greater labor
market tightness.
Time-series evidence
Figure 3 displays forecasts of the rate
of CPI inflation for 1996 based on
two simple statistical models.  Both
are vector autoregessions that contain
changes in the monthly rate of CPI
inflation.  In addition, the model
whose forecast is shown in the first
row contains changes in the unem-
ployment rate, while the model gen-
erating the second row contains
changes in the unemployment rate
as well as changes in the level of aver-
age unemployment duration.
The detailed specification of these
models follows that in King, Stock,
and Watson (1995).3  They contain
12 lags of the monthly data and are
estimated over the period from Janu-
ary 1974 to December 1995.  The use
of changes of the unemployment rate
and average duration is motivated by
evidence that secular movements in
these series are unrelated to inflation.
Using only the recent history of in-
flation and unemployment yields an
inflation forecast of 2.0% for 1996.
However, when recent data on aver-
age unemployment durations are
added to the model, the forecast
rises to 2.5%.  Thus, at least at the
present time, accounting for unem-
ployment durations increases esti-
mates of inflationary pressures.  This
is consistent with the view that the
long-term unemployed are less rele-
vant to wage determination than
other unemployed workers.
Finally, it should be noted that these
forecasts are intended only to illus-
trate the effect of adding information
on unemployment durations to the
analysis of inflationary pressures.
They ignore other indicators such as
capacity utilization, the gap between
actual and potential GDP, commodi-
ties prices, and numerous monetary
and financial variables that contain
useful information about inflation.
When these are factored into the
analysis, Chicago Fed staff economists
arrive at a 1996 inflation forecast of
approximately 2.75%.
—Daniel Sullivan
Assistant vice president
1See, for example, Gene Epstein, “How
low can it go?—Jobless rate hasn’t slid to
optimum level yet,” Barron’s, September
25, 1995, p. 46.
2Chinhui Juhn, Kevin Murphy, and
Robert Topel, “Why has the natural rate
of unemployment risen?” Brookings
Papers on Economic Activity, Vol. 2, 1991,
pp. 75–126.
3Robert G. King, James H. Stock, and
Mark W. Watson, “Temporal instability
of the unemployment-inflation relation-
ship,” Economic Perspectives, Federal Re-
serve Bank of Chicago, Vol. 19, No. 3,
May/June 1995, pp. 2–12.
Information Forecast
12/95–12/96
Changes in inflation
and unemployment 2.0%
Changes in inflation,
unemployment, and
unemployment durations 2.5%
Source: Author’s calculations based on U.S.
Department of Labor, Bureau of Labor
Statistics, various releases.
mentioned in the last section.  Work-
ers who have been permanently laid
off are presumably more receptive to
jobs entailing wage cuts than those
who expect to be recalled to their old
jobs.  Similarly, white-collar and other
workers who have lost jobs where
specialized skills were important likely
realize their need to show flexibility
with regard to wages.
Those who argue that high durations
imply less inflationary pressure appar-
ently believe inflation is largely deter-
mined by labor market conditions.
This view is controversial because, in
its extreme form, it ignores the role
of money in determining inflation.
However, even within such a frame-
work, high durations could mean
more inflationary pressure.  First, the
low rates of new unemployment which
are the corollary of high durations
may imply less fear of job loss and,
hence, more aggressive wage de-
mands.  Second, the long-term unem-
ployed are less likely to take jobs in a
given month and thus may be less
relevant to wage determination.
Moreover, if the current rise in un-
employment durations reflects a
continuation of the long-term trends
identified by Juhn et al., then many
of those experiencing long unem-
ployment spells may lack the skills
demanded by prospective employers.
Thus, they may be less relevant for
the determination of wages than
other unemployed workers and high
durations may be taken as a sign of
labor market weakness.
Even if the reason for higher dura-
tions is the increased prevalence of
permanent layoffs or job loss by
Michael H. Moskow, President; William C.
Hunter, Senior Vice President and Director of
Research;  Douglas Evanoff, Assistant Vice President,
financial studies; Charles Evans and Kenneth
Kuttner, Assistant Vice Presidents, macroeconomic
policy research; Daniel Sullivan, Assistant Vice
President, microeconomic policy research;  William
Testa, Assistant Vice President, regional programs;
Anne Weaver, Manager, administration;  Helen
O’D. Koshy, Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago.  The views expressed are
the authors’ and are not necessarily those of
the Federal Reserve Bank of Chicago or the
Federal Reserve System.  Articles may be
reprinted if the source is credited and the
Research Department is provided with copies of
the reprints.
Chicago Fed Letter is available without charge
from the Public Information Center, Federal
Reserve Bank of Chicago, P.O. Box 834,
Chicago, Illinois,  60690-0834, 312-322-5111.
ISSN 0895-0164
3. Forecasts of 1996 CPI inflationP
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Sources: The Midwest Manufacturing Index (MMI)
is a composite index of 15 industries, based on
monthly hours worked and kilowatt hours.  IP rep-
resents the Federal Reserve Board industrial pro-
duction index for the U.S. manufacturing sector.
Autos and light trucks are measured in annualized
units, using seasonal adjustments developed by the
Board.  The purchasing managers’ survey data
for the Midwest are weighted averages of the sea-
sonally adjusted production components from the
Chicago, Detroit, and Milwaukee Purchasing Man-
agers’ Association surveys, with assistance from
Bishop Associates, Comerica, and the University of
Wisconsin–Milwaukee.
Motor vehicle production
(millions, seasonally adj. annual rate)
Dec. Month ago Year ago
Cars 6.1 6.1 6.8
5.4 5.4 5.4 Light trucks
1993 1995 1996
Manufacturing output indexes
(1987=100)
Dec. Month ago Year ago
MMI 142.1 142.7 141.4
123.8 124.7 124.8 IP
Purchasing managers’ surveys:
net % reporting production growth
Dec. Month ago Year ago
MW 55.7 52.5 68.9
59.4 46.1 47.0 U.S.
1994
3.0
4.5
6.0
7.5
Motor vehicle production (millions, seasonally adj. annual rate)
Cars
Light trucks
In December 1995, Midwest manufacturing activity experienced its biggest
decline since last March.  After reaching its highest level of the year in Septem-
ber, the MMI began a slight trend downward.  In contrast, the national mea-
sure of manufacturing activity was virtually flat in December and only slightly
below its September peak.
Other measures of manufacturing activity suggest more underlying strength to
regional production.  For example, purchasing managers’ surveys for Chicago,
Milwaukee, and both the auto and nonauto portions of Detroit indicated im-
provements in production for December, while western Michigan showed con-
traction.  Auto production, both nationally and regionally, actually increased
slightly in December after being flat for two months.
Tracking Midwest manufacturing activity

Unemployment duration and labor market tightness

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Unemployment duration and labor market tightness

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