While unemployment dropped last month to 7.3 percent, the lowest level since December 2008, the decline occurred because of contraction in the workforce, not because more people got jobs. Labor-force participation -- the share of working-age people either holding a job or looking for one -- stands at a 35-year low.
The reduced workforce “poses a problem for the Fed,” said Roberto Perli, a former central bank official who is now a partner at Cornerstone Macro LP in Washington. “Theunemployment rate is coming down faster than the Fed thought, but it’s not declining for the right reason.”
The jobless rate is important because Chairman Ben S. Bernanke and his colleagues have established it as the lodestar for policy. Bernanke has said he expects the Fed to complete its asset-purchase program in the middle of next year when unemployment is around 7 percent.
So long as inflation remains contained, the central bank has said it won’t even consider raising its benchmark interest rate until unemployment falls to 6.5 percent. The Fed cut its target for the overnight interbank rate effectively to zero in December 2008 and has held it at that record low.
A key question facing policy makers is how much of the decline in the participation rate is structural and long-lasting and how much is cyclical and temporary.
If the drop is mainly driven by demographics -- aging baby boomers retiring -- then the lower unemployment rate gives a true picture of the amount of slack left in the labor market. If the contraction instead is caused by discouraged job-seekers giving up their search, then the jobless rate doesn’t reflect the true state of the market.
Both alternatives have implications for bond investors. A quicker swing from stimulus to austerity by the Fed would push up yields on Treasury securities. John Herrmann, director of U.S. rate strategy at Mitsubishi UFJ Securities USA Inc. in New York, forecasts the yield on the 10-year Treasury note will rise to 3.25 percent by the end of this year as the jobs market strengthens. It was 2.93 percent at 4 p.m. in New York on Sept. 6, according to Bloomberg Bond Trader data.
Since hitting a 26-year high of 10 percent in October 2009, the unemployment rate has fallen 2.7 percentage points, according to the Labor Department in Washington. A big portion of that decline -- 1.8 points -- was because of a drop in labor-force participation to 63.2 percent.
Central bank economists are divided over how much of the fall in the workforce is structural and thus not likely to be reversed.
“There is disagreement within the system,” said Geoffrey Tootell, senior vice president and director of research at the Federal Reserve Bank of Boston.
A July 2013 paper by Boston Fed economists Michelle Barnes, Fabia Gumbau-Brisa and Giovanni Olivei concluded that a significant portion of the drop since the start of the last recession results from demographic and other developments that probably will persist.
“About two-thirds of the decline has been trend” due to secular forces, Olivei said. He reckons the participation rate now is about three-quarters of a percentage point below where it otherwise would be because of temporary forces stemming from the 2007-09 recession and the muted recovery since then.
His estimate contrasts with research by Julie Hotchkiss, a senior adviser at the Atlanta Fed. In a paper with Georgia State University’s Fernando Rios-Avila that was published in March, she argues that cyclical influences are all-important in explaining the shrinkage in the labor force.
If the labor market recovers to pre-recession levels, the participation rate over the years 2015 to 2017 will average a about third of a percentage point more than it did from 2010 through 2012, they found. That would put it at 64.5 percent.
At that level, payrolls would have to rise close to 425,000 per month for the Fed to achieve its forecast of 7 percent unemployment by the middle of next year, according to a jobs-calculation formula developed by Atlanta Fed economists.
If participation held steady at its current level, payrolls would have to increase about 142,000 a month. The average so far this year has been 180,250.
The continued contraction in the number of workers, even as the job market improves, is raising questions at the Fed about how much of the shrinkage is temporary and will be unwound, saidMichael Feroli, a former central-bank researcher who is now chief U.S. economist at JPMorgan Chase & Co. in New York.
He said the consensus within the central bank seems to be shifting toward seeing the fall as more long-lasting and structural than cyclical.
“More and more, that seems to be the way they’re going,” he said.