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Will Unemployment Clear 10 Percent? Probably.

Both Jon Chait and Zubin cite this excellent Nate Silver post bringing some data to bear on whether the unemployment rate will pass 10 percent. Silver's argument is partly a response to my point that, as the economy improves and people not previously considered part of the labor force start looking for jobs, the ranks of the unemployed will swell (and the unemployment rate will rise) even if the pace of job losses slows or we start creating jobs. Says Silver:

If we look back at past recessions, we find that the labor force grew by an average of 0.44 percent in the six months after they were declared over. This compares to an average of 0.77 percent growth for all six-months periods since 1948.

People do not jump right back into the labor force the moment a recession is over. Oftentimes, indeed, they can’t, because they’ve made somewhat long-term commitments – good luck ditching the army because the local bank is having a hiring fair back at home in Topeka. These effects are fairly strongly lagged, probably by at least 3-9 months, and usually occur only once the jobs picture has gotten to the point where it’s actually pretty darn good – not just when it’s merely improving. Where we’ll see these effects is in, say, January of 2011, when the employment rate might not budge much even if a couple hundred thousand new jobs are created. But the unemployment rate should already be safely clear of 10 percent long before that.

If the labor force grows at its typical post-recessionary rate of 0.44 percent over the next six months, that means that the economy will need to avoid losing 375,000 more jobs between now and January for unemployment to stay below 10 percent. While there will almost certainly be some additional job losses this month and probably in September, I’d take about even odds on the economy gaining or losing jobs in October and November, and expect it to probably be creating jobs in December and January. In other words, I think it will win the race against the growth of the labor force. The most likely scenario is that the unemployment rate will flirt with 10.0 percent but not quite reach it.

I think this is entirely plausible. My only word of caution is that the analysis is based somewhat precariously on the pattern of postwar U.S. recessions. If this recession ends up behaving like those, then there's good reason to think Silver is right. But there's reason to think this recession is different since, unlike them, it was the result of a deep financial crisis. The key feature of that kind of recession is that households and companies tend to be saddled with large piles of debt, which can dramatically slow the rate at which consumption and hiring rebound.

The most authoritative recent analysis of this phenomenon comes from economists Carmen Reinhart and Kenneth Rogoff. Reinhart and Rogoff restrict their sample to recessions that follow deep financial crises and find that, on average, the unemployment rate rises by a disheartening 7 percentage points. As of this month, we're up only about five from the low-point in March, 2007. Now, obviously, this analysis is somewhat crude, since it lumps together advanced and emerging-market economies (and, within those, economies that have vastly differently labor markets). But I'm not sure it's any more crude than extrapolating from previous postwar recessions. (Don't get me wrong--I'm not criticizing Silver here. This sort of modeling may be crude, but there isn't a great alternative, and it certainly beats other popular methods, such as "going with your gut.")

The big problem with invoking the Reinhart and Rogoff paper to justify my pessimism is that it's not clear what the mechanism would be for driving unemployment up further. If businesses were buried under a lot of debt, as often happens in these sorts of recessions, you could understand their being reluctant to hire. But going into this recession, the big debt problems were on the consumer side of the economy, not the corporate side.

If I had to guess, I'd say the reason we won't see enough hiring to keep unemployment below 10 percent is that companies are going to worry about the sustainability of the rebound precisely because of all that consumer debt. That is, it's not clear how the economy can grow (at least after an initial blip owing to the re-stocking of inventories) if consumers aren't spending in earnest. And that could take years to happen given the state of their finances. (I actually discuss this in a piece that should be up this week.)

Also, there's one other way Silver may be too optimistic: He implicitly argues that, if we get through the next six months without hitting 10 percent unemployment, we're probably in the clear. But even by the standards of our recent recessions, I don't think this is true. If you look at the last recession, for example, the economy was growing by the fourth quarter of 2001, and it grew at a pretty healthy clip throughout 2003. But the economy shed 300,000 jobs as late as July of 2003 (and nearly 500,000 jobs in November of 2002). Unemployment didn't hit its peak until June 2003, a good year-and-a-half after the recession had officially ended. All told, it rose another .8 points during the ostensible recovery. As I've said, it's not a great idea to extrapolate from previous U.S. recessions. But if you were doing an incredibly crude extrapolation based on 2001 (and Silver's extrapolations are much, much more sophisticated), you could easily imagine unemployment rising another point or so during the first year to year-and-a-half of the recovery. Which, unfortunately, brings us well over 10 percent heading into next year's midterm elections.