Did Discouraged Workers Spook the Fed?

Photograph by Justin Horrocks

Out of work, sitting on the steps of the old office building.

The Federal Reserve today, shocking most observers, announced it would continue its stimulus policies without easing up on bond purchases. The news sent U.S. markets to record highs. The big surprise here is that almost everyone expected the Fed to start tapering now that unemployment is drawing close to 7 percent.

Except that it’s not. As folks have been pointing out for a while (see, for instance, The Atlantic’s Jordan Weissmann), the unemployment rate — now 7.3 percent — has been driven significantly not by workers gaining jobs, but by people giving up on looking work and  no longer getting counted in the unemployment number. You can see the pattern in the chart of labor force participation to the left; the end of the recession and nominally improving economy have hardly slowed the outflow of workers from the labor force.

Bloomberg’s Rich Miller may have called this a week ago, explaining that the Fed is faced with the dilemma of figuring out whether, considering the increase in discouraged workers, the rate really reflects the state of the market. That feels like the best explanation of the Fed’s decision. Another factor here could be that the Fed was worried by a dramatic drop in housing starts and mortgages. Jeff Kearns highlighted this in a Bloomberg story earlier today, noting it could be a strong argument against cutting the stimulus.

The expectations of Fed tapering have already sent 30-year mortgage rates shooting up to 4.57 percent, more than a point above the near-record low in May. In the face of a weak recovery, nobody is eager to dampen the housing upswing. The implicit hope of economists is that eventually other sectors will strengthen enough that we don’t need to goose housing with ultra-low rates. What those sectors are supposed to be is anyone’s guess.

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