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Here’s the employment to population ratio–check out the 1960s and 1970s:

Was the labor market healthier in the 1970s than the 1960s? Of course not, the opposite was clearly true. You probably couldn’t find a single macroeconomist in America who thinks our labor market was healthier in the 1970s than the 1960s. The whole idea is preposterous. And yet the employment ratio was far higher in 1978 than 1972, and higher in 1972 than 1965 (which was a boom year.)

Was the labor market healthier in 2012 2006 than 2006 2012? Yes, that’s obviously true. But it’s equally true that we can’t make that inference from this graph, which doesn’t tell us much of anything about the health of the labor market. The problem is that the trend employment to population ratio was sharply rising after 1964, before peaking around 2000. Now it is on a sharp downtrend. The current labor market is weak (7.8% unemployment, even more if you count part timers who want to work full time) but the graph tells us very little about that weakness.

If you look at the graph it would appear that the US labor market is not healing, which might make one skeptical of the sticky wage theory. But once one realizes that the graph does not describe the health of the labor market, and that you must look at unemployment rates, the picture changes radically. Now we see a labor market that has created 5 million jobs in recent years, where the unemployment rate has fallen from 10% to 7.8%. Indeed the only reason Obama has even a prayer of winning this election is the huge fall in unemployment in states like Ohio and Michigan. If their labor markets had not improved he’d be toast right now.

I’m not sure why the employment to population ratio is now on a downtrend. Obviously the big recent drop is partly the recession. But the trend also picks up a growing number of old people who are out of the workforce, more people on disability, a falling preference for work among upper-middle class teens, and lots of other factors. Maybe even more people in prison.

Even when the economy is fully recovered we won’t get back to the 2007 peak, and we won’t even get close to the 2000 peak. But that fact will tell us nothing about whether we have restored equilibrium in the labor market.

PS. This post is a sort of reply to a recent Tyler Cowen post. This is puzzling:

In one very real sense, there is a significant demand shortfall. Yet repairing that demand shortfall requires many building blocks. Nominal reflation (which I favor) is only one of those building blocks. The others are rooted in trust and perceived real wealth, which are both slower to repair and require different policy instruments, plus the mere passage of time.

Tyler defines “demand” differently from most macroeconomists. He doesn’t mean aggregate demand, as on an AS/AD diagram, he means something closer to quantity demanded, i.e. real output. Trust boosts AS, not AD. Trust will boost output even if the Fed targets NGDP. On the other hand a true AD factor would not boost output if the Fed targeted NGDP.

PPS. I might add that as each month goes by, and the unemployment rate falls to lower and lower levels, and 5,000,000 new jobs are created, I find it odd to see a rapid increase in blog posts that tell us why the unemployed won’t be able to find jobs, and that the problem is structural. So here’s my question–where do the structuralists think the unemployment rate is headed?

PPPS. This post should not be construed as a denial of structural problems. A significant share of the job loss reflects early retirees, disability rolls, extended UI benefits, etc. But there’s still a lot of cyclical unemployment. And more AD will lead Congress to trim back on UI.

PPPPS. And if you don’t think unemployment will fall, do you want to make a bet? (Not with me, with Bryan Caplan)

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