What happens to unemployment rates after a recession?
Written by Patty Silverstein, chief economist for the Metro Denver EDC, this section identifies major issues affecting the economy and answers frequently asked questions.
Economists are predicting increasing unemployment and a rising unemployment rate into 2010 despite forecasting the recession to end sometime in the last half of 2009. Is this a paradox? Intuitively, it seems that if an economy is expanding then businesses will be hiring and the rate of unemployment should drop. However, looking back on the recession ending in 2001, it took 19 months for the national unemployment rate to peak and then decrease after the expansion started.
Many sources project that the trend for the current recession will be no different with unemployment rates peaking after the trough of the business cycle. For instance, Chairman of the Federal Reserve Board of Governors Ben S. Bernanke, in a recent testimony to the House Budget Committee, projected that the recession would end by the end of this year. Yet he also states that unemployment “is likely to rise for a time, even after economic growth resumes.” In order to analyze this phenomenon, here are a few questions and answers to explore the unemployment rate, recessionary trends, and their relationship to each other.
Q: Does the unemployment rate historically continue to increase after the end of a recession?
The official declaration of a business cycle contraction, or recession, comes from the National Bureau of Economic Research (NBER). The NBER is a private, non-profit research organization founded in 1920. Since December of 1969, the NBER has identified seven U.S. 
recessions. The current recession officially started in December 2007 and the NBER has not yet declared an end to this downturn.
Based on the NBER business cycles and seasonally adjusted national unemployment rate data from the U.S. Bureau of Labor Statistics, the unemployment rate has increased and peaked after the end of the prior six recessions in the U.S. The length of time between the end of a recession and the peak in unemployment varies with each recession and appears to be increasing over time. Indeed, after the 2001 recession we often heard economists refer to the economic situation as a “jobless recovery.”
Q: Why does the unemployment rate continue to rise after the end of a recession?
There are a number of reasons that the unemployment rate continues to rise after the trough of a recession. The least complex reason is the methodology the NBER uses to determine the end of economic contractions and the start of economic expansions. According to the NBER, unemployment is only one of several indicators used to identify when a contraction ends and an expansion begins. In determining a recessionary trough, the NBER gives more weight to the growth in national gross domestic product and productivity. Productivity growth tends to precede growth in employment. According to the NBER’s announcement of an economic expansion beginning in November 2001, “The NBER defines expansions and recessions in terms of whether aggregate economic activity is rising or falling, and it views real GDP as the single best measure of economic activity. Real GDP has risen since November 2001. 
However, this growth in real GDP has resulted entirely from productivity growth. As a result, the growth in real GDP has been accompanied by falling employment. Unemployment has risen because of falling employment and because the labor force has been rising.” Indeed, employers often continue to shed jobs even after the official end of a recession. The chart below shows that over-the-year growth in total non-farm employment continued to be negative after the last six recessions ended.
Other reasons are as follows:
- The labor force may grow despite economic expansions or contractions. The labor force is defined by the U.S. Bureau of Labor Statistics as the civilian population over the age of 16 years old who are either employed or who want to work and are actively seeking employment (the unemployed). When the labor force grows while businesses are shedding jobs or are reluctant to hire, the unemployment rate increases.
Sources of growth are re-entrants to the labor force and new entrants to the labor force. While the number of new entrants to the labor force mainly follows demographic changes, re-entrants to the labor force after a recessionary trough could be formally discouraged workers who, upon seeing economic conditions improve, decide to actively seek employment again.
- Employers continue to shed jobs in order to cut costs. Job losers and other workers who have completed temporary jobs are the biggest component of the unemployed labor force during a recession. As the chart above shows, over-the-year growth in employment continues to be negative even after the official end of a recession, although it is declining at a decreasing rate.
- Employers remain reluctant to hire new workers. The trend for employers to be reluctant to hire following a recession is evident even at a local level. The Manpower Employment Outlook Survey published by Manpower, Inc. tracks the percent of companies hiring, laying off, maintaining current employment levels, or are unsure. In 2001, the percent of companies in the Denver area who were hiring dropped to 15 percent in third quarter 2003 from 26 percent in third quarter 2001. Concurrently, the percent of companies who were laying off rose to 20 percent in third quarter 2003 from 9 percent in third quarter 2001. The percent of companies either laying off, maintaining current employment levels, or were unsure rose from 74 percent to 85 percent over the same time period. Employers tend to wait for uncertainty to clear and markets to improve before they make significant hiring decisions. This reality is evident in the current recession as well. Since fourth quarter 2007 when the recession started, the percent of companies who are unsure whether they will hire or lay off has risen from 52 percent to 73 percent in the second quarter 2009.
Q: Once a recession ends, how long does it take before the unemployment rate begins to drop?
The time it takes for the employment rate to peak after the end of a recession varies widely. While an unemployment peak after a recession appears to be a trend, the timing depends on when the NBER declares a trough in the business cycle. The NBER also reserves the right to revise the business cycle data as it sees fit. Current data on the recession ending in November 1975 indicates that the unemployment rate peaked just two months after the recession ended. However, the unemployment rate did not peak for 19 months following the end of the 2001 recession. The length of time between the end of a recession and peak unemployment has increased over the last few recessions. This may be a result of increases in productivity that do not necessarily correlate with employment levels. The NBER also considers increases in other output-related indicators such as personal income, industrial production, and sales that may also precede a decrease in unemployment.
Q: Why might an increase in economic activity precede a decrease in the unemployment rate?
To reiterate, the NBER places more emphasis on output-related measures such as GDP, personal income, industrial production, and sales, than on labor-related indicators like the unemployment rate. When an economic contraction is slowing and an expansion is beginning, employers might be able to bring idled factory capacity back online without significant numbers of new employees. Businesses may also increase the number of hours worked before they hire new workers to fill open positions. Another possibility is employers defer recessionary responses like mandatory time-off and bring back furloughed workers before they hire again. These decisions would be in response to an increase in sales and would raise personal incomes. While the decisions businesses make in response to a recession are complex, the last few recessions seem to indicate that an employment lag will continue to be the norm.
Sources:
1. Ben S. Bernanke, “Statement by Ben S. Bernanke Chairman Board of Governors of the Federal Reserve System before the Committee on the Budget U.S. House of Representatives,” Committee on the Budget, U.S. House of Representatives, June 3, 2009, http://budget.house.gov/hearings.aspx.
2. Business Cycle Dating Committee, “Business Cycle Expansions and Contractions,” National Bureau of Economic Research, http://wwwdev.nber.org/cycles/cyclesmain.html
3. Current Population Survey, “Labor Force Statistics including the National Unemployment Rate,” U.S. Department of Commerce, Bureau of Labor Statistics, http://www.bls.gov/cps/.
4. Business Cycle Dating Committee, “July 2003 Announcement of Business Cycle Trough,” National Bureau of Economic Research, July 17, 2003, http://www.nber.org/cycles/july2003.html.
5. Current Employment Statistics, “Employment, Hours, and Earnings from the Current Employment Statistics Survey,” U.S. Department of Commerce, Bureau of Labor Statistics, http://www.bls.gov/ces/.
6. The civilian labor force is the sum of the employed plus the unemployed. The employed are all persons who did any work as paid employees, worked in their own business, or worked 15 hours or more as unpaid workers in an enterprise operated by a member of their family, and those who were not working but who had jobs or businesses from which they were temporarily absent. The unemployed are persons who had no employment, but were available for work, had made specific efforts to find work in the last four weeks, or were waiting to be recalled to a job from which they had been laid off regardless of whether they have been looking for work. For more information see the U.S. Bureau of Labor Statistics website, www.bls.gov/cps/.
7. Manpower Research Center, “Manpower Employment Outlook Survey,” Manpower, Inc., http://manpower.mediaroom.com/index.php?s=38.
8. Denver area defined as the Denver-Aurora Metropolitan Statistical Area.