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January 12, 2021
RESEARCH FOCUS — Shigeru Fujita, a research economist at the Federal Reserve Bank of Philadelphia, is trying to understand how overall labor market participation rates change depending on the strength of the economy.
Throughout the ups and downs of the economy, people decide whether to join the labor force or become “nonparticipants.” These decisions and their effects are increasingly being studied by economists. Nonparticipation differs from unemployment in that unemployed people, by definition, actively seek work, whereas nonparticipants are out of the labor force because they are either retired or disabled, perform unpaid work exclusively at home, or are discouraged workers who perceive no job prospects and choose not to enter the labor market. In recent years, Federal Reserve officials have noted the importance of labor force participation in understanding unemployment trends. For example, in a 2014 speech, Federal Reserve Chair Janet Yellen spoke about the need to better understand cyclical (and structural) factors that affect labor force participation when estimating labor market slack.1
In their working paper, “Cycling in Labor Force Participation Flows: The Role of Labor Supply Elasticity and Wage Rigidities” (2020), Fujita and Federal Reserve Board members Isabel Cairo and Camilo Morales Jimenez investigate cyclical patterns in labor market transitions between employment, unemployment, and nonparticipation.2 They observe the pace at which people enter and exit the labor market in response to fluctuations in overall economic activity. They model these labor force participation dynamics by linking household-level decisions to economy-wide labor market fluctuations.
First, they study the relationship between labor market transition rates, job openings, and real wages. Transition rates measure the pace at which individuals move between employment, unemployment, and nonparticipation. To understand the underlying factors that determine labor market dynamics, they employ a “search and match model,” linking workers looking for work with employers looking to fill jobs, and extend the model to consider labor force participation decisions. Their model depicts a representative household that must decide whether to participate in the labor market or engage in home production. The authors explain that people evaluate this participation decision by considering how productive household members are at home.3 The authors call this the “participation margin,” which can be thought of as the threshold at which more productive people at home drop out of the labor market and less productive people at home join the labor pool in search of work. This participation margin has a direct impact on the size of the unemployment pool in the economy over the course of the business cycle.
The authors find that the decision to look for work is countercyclical, meaning that during economic expansions people are less willing to join the ranks of unemployed people looking for work. The authors find two equally important reasons why participation rates are countercyclical. One factor is wage rigidity: during economic expansions, wages tend to rise only slowly despite tight labor market conditions, thereby suppressing the returns to market labor. This makes people less willing to participate in the labor force during economic expansions, leading to lower labor force participation rates during economic expansions.
The second factor has to do with how households value home and “non-market” activities at different points in the business cycle. The authors find that during economic expansions, people value leisure activities and home production more. As such, they are less likely to join the unemployed in search of work during boom times. The authors note that this result may seem counterintuitive because jobs are easier to find during economic expansions, motivating people to join the labor force. However, the authors find that the most important factor influencing the decision to participate in the labor force is that people value home activities more when the economy is doing well. The authors find that the opposite happens during recessions, with labor force participation rates rising. People may need to join the labor force. For example, when a working member of a household loses hours or a job during a recession, another household member is motivated to join the labor force to make up for the loss in income.
Cairo, Fujita, and Morales-Jimenez conclude that “the unemployment pool expands during recessions not only because the pace of unemployment increases and the pace of hiring slows, but also because the rate of entry into the pool from nonparticipants increases and the rate of exit to nonparticipants slows.” Their findings provide important information for policymakers implementing plans to maximize employment under a range of macroeconomic conditions.
1 Janet L. Yellen, “Labor Market Dynamics and Monetary Policy”, Speech at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 22, 2014.
2 The views expressed in this paper are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System.
3 The authors use household production data from the American Time Use Survey (ATUS), which includes household activities such as preparing food, cleaning, and caring for household members.
