Can Jobs Grow With Low Unemployment?

Will our low unemployment rate limit future job growth? It stands to reason that as we run out of unemployed people, we will no longer be able to keep adding new jobs. However, reality is more complicated. For at least a year—and perhaps for three years—after we hit “full employment,” the economy will generate additional job growth.

In past cycles, I’ve seen employment gains that surprised me. It seems like people come out of the woodwork when jobs are available. An interesting report on hires and job search bears this out. Last year, 42 percent of the people who were hired did not have a job and reported that they had not been looking for work. They probably heard about the job opening from a friend or saw a random “help wanted” sign.

For how long can total employment increase when the job market is tight? To get at this, I defined “tight” as when the actual unemployment rate was below the “long-term natural rate of unemployment,” a concept estimated by the Congressional Budget Office. The chart below shows, for each month in which the actual unemployment rate was below the natural rate, the percentage employment gains in the following 12 months. If low unemployment were an absolute limit, employment growth would have been zero, or at least limited to population growth.

Although 1970 was a little weird, all of the other spells of low unemployment follow a simple pattern: job growth is high when the unemployment rate first gets low. (I don’t plot job growth when the unemployment rate is not low.) Then job growth declines, eventually going negative. How long can job growth continue once we go below the natural rate of unemployment? Here’s my tabulation:

1971: 23 months

1977: 14 months

1987: 26 months

1996: 39 months

2005: 17 months.

Every episode of low unemployment ended poorly. While unemployment was still low, job growth turned negative. Each of those episodes ended in recession.

The concept of the economy eventually reaching a limit makes sense. Using the concept for a short-term forecast is more difficult, but it certainly appears that our current low unemployment rate will not limit economic growth in 2015, and probably not in 2016 either.