Also in town for last week’s International Symposium on Forecasting was Bill Gavin from the Federal Reserve Bank of St. Louis. I had an interesting discussion with him about changes over time in U.S. employment dynamics that I wanted to share with our readers.

In the earlier postwar recessions, the unemployment rate began to fall very quickly once the expansion began. By contrast, the unemployment rate continued to climb even after the recovery had begun for the 1990-91 and 2001 recessions. No one is predicting a rapid drop in the unemployment rate this time around, either.

Unemployment rate. Seasonally adjusted number of unemployed as a percent of U.S. civilian labor force. Source: BLS, Table A-1. Shaded regions represent U.S. recessions, with 2009:M6 interpreted as the last month of the most recent recession.

Bill called my attention to the contribution of temporary layoffs to this changing behavior in the unemployment rate. He noted that the Social Security Amendments of 1958 explicitly exempted unemployment insurance from income taxation, and recalled a 1976 paper by Martin Feldstein which proposed that this gave firms a strong incentive to use temporary layoffs in response to a business downturn. By temporarily laying workers off rather than asking them to work shorter hours, the firm could deliver maximal after-tax compensation to its labor force, intending to hire those same workers back as soon as business improved. Temporary layoffs accounted for up to a quarter of those unemployed at the worst of the 1973-75 recession.

Fraction of unemployment accounted for by temporary layoffs. Calculated as 100 times the ratio of seasonally adjusted number of unemployed as a result of temporary layoffs to the seasonally adjusted total number of unemployed. Source: BLS, Tables A-6 and A-1.

Bill believes that the key developments that changed this dynamic were the Revenue Act of 1978, which subjected unemployment benefits to partial taxation under the income tax law, and the Tax Reform Act of 1986, which made unemployment benefits taxable as ordinary income. Since the mid-1980s, the above graph shows that temporary layoffs have become a much less important feature of recessions.

Suppose you adopted Feldstein’s perspective that those individuals who fully expected to get back their old jobs soon are not really unemployed, but should instead be viewed the same way we treat workers who remain employed but work shorter hours. If you subtract temporary layoffs from the number of unemployed, here’s what the adjusted unemployment rate would look like. The earlier recessions look much more like the recent jobless recoveries.

Adjusted unemployment rate. Seasonally adjusted number of unemployed less those unemployed from temporary layoffs as a percentage of the civilian labor force. Source: BLS, Tables A-6 and A-1.