[Excerpt] Even though the economy seems to be growing again, it may be a while before the unemployment rate begins to decline, and it may even continue rising for some time after the resumption of sustained economic growth. The unemployment rate is generally a lagging indicator, meaning that its ups and downs happen some time after the ups and downs of other broad indicators of economic activity.
Unemployment may not fall appreciably when economic growth first picks up because some firms may have underutilized labor. At the end of a recession as demand increases, some firms may initially be able to increase production without adding workers. Firms may be able to increase their output by raising the productivity of the labor on hand.
Over the longer run, there tends to be a link between the rate of economic growth and changes in the unemployment rate. Estimates based on data since 1949 suggest that real economic growth of about 3.5% was associated with a stable unemployment rate. When economic growth was faster than 3.5%, the unemployment rate tended to fall, and when economic growth was below 3.5% the unemployment rate tended to rise.
In the long run, a one percentage point difference in the economic growth rate has historically led to a change in the unemployment rate of about 0.4 percentage points. In other words, although economic growth of 3.5% was sufficient to maintain a stable unemployment rate, an annual increase in real output of 4.5% would result in a decline in the unemployment rate of 0.4 percentage points.
Even if economic growth picks up and an expansion gets going, experience suggests it may be some time before there are significant declines in the unemployment rate. After the end of the two most recent contractions, it was well over a year before there was a clear downward trend in the unemployment rate. After nine of the past 10 contractions, it took at least eight months for the unemployment rate to fall by one full percentage point.
This report examines the relationship between economic growth and the unemployment rate to anticipate possible future developments.