Trailing 12 month average civilian labor force growth, seasonally adjusted, 2002 to present. Source: Federal Reserve Bank of St. Louis
Trailing 12 month average civilian labor force growth, seasonally adjusted, 2002 to present. Source: Federal Reserve Bank of St. Louis

The American labor force is growing again. After three years of falling participation starting in 2009, this year has brought a return to the normal rate of growth seen before the recession, with roughly 150,000 joining the labor force every month.

That is excellent news for the American economy, whose long-run growth depends on increasing its supply of resources -- such as labor -- and increasing the productivity with which it employs them. And the entrance of workers into the labor force is itself a signal of confidence in continued economic growth, as these workers expect to find employment soon.

It also means an end to some bad news: 5 to 6 million Americans did not join the labor force during the recession, and they represent approximately $272 billion in lost potential output, or 2 percent of total potential output, per year. In other words, fewer people in the workforce means more people sitting around not being productive. Labor force growth will prevent those losses of potential output from growing larger.

And yet, the restoration of labor force growth creates new headwinds for the recovery and new problems for policymakers. As more people look for jobs, it will become a growing problem that the economy is not creating enough.

The current rate of growth in actual employment -- also 150,000 per month, on rough average -- will no longer be sufficient to bring down the total number of Americans without work. Year-over-year job creation less labor force growth has been effectively zero for the last two months, and without a significant acceleration in the rate of net job creation, the unemployment rate will stay near 8.3 percent indefinitely.

Few Americans will find such an outcome acceptable. The drop of the unemployment rate over the prior two years had been greatly assisted by the lack of labor force growth. With few new people beginning the search for work each month, the total number of unemployed fell despite the economy's weak rate of job creation. Economist Betsey Stevenson even deemed the phenomenon a "jobful" recovery -- declining unemployment alongside weak GDP growth, unlike other recent "jobless" recoveries, when unemployment rose even as GDP recovered more strongly.

For the unemployment rate to continue declining at roughly one percentage point per year as it did in 2010 and 2011, the United States would need double the rate of job creation, bringing it from 150,000 a month to 300,000 a month. Even at that elevated rate, it would take three more years for the U.S. economy to reattain full employment, which the Fed considers to be an unemployment rate between 5 and 6 percent.

Increasing the rate of job creation to 300,000 a month is no small endeavor. Over the last few decades, the U.S. economy has only sustained such growth at the height of the booms of the 1980s and 1990s, and for a brief period during the 2000s.

There are few plausible options to keep the unemployment rate falling in the near term. A sudden boom in the private sector seems unlikely -- but hardly less so than the alternative, an expansion of government employment, given America's poor fiscal shape and political gridlock.

Structural reforms that diminish the costs and risks associated with hiring, such as a special lower minimum wage for teenagers, entitlement reform that allows for reduction in the payroll tax, or reforms that reduce medical-care cost inflation, would all be challenging to enact, and would not have large short-term effects.

The best hope for faster job creation lies in monetary policy. In 2010 and 2011, the Federal Reserve was able to sidestep calls for more aggressive action because of a declining unemployment rate amid what was ultimately a feeble recovery. As the unemployment rate stagnates, there will be more pressure for more monetary stimulus.

Contrary to the insistence of the Fed's more hawkish governors, there is considerable room for further monetary policy action without levels of inflation that would violate the Fed's dual mandate. Given high unemployment and low capacity utilization, monetary expansion is likely to be met by growth in real production rather than increases in prices. That would be particularly true if the Fed chose not to launch a third round of discretionary quantitative easing but rather a rule-based policy, such as targeting the pre-recession growth path of nominal GDP.

Although recent improvement in the economic outlook may take "QE3" off the table for the next few months, it may not be long before a lack of progress on the unemployment rate compels the Fed to get back into the game. If the Fed demurs, the "jobful" recovery of 2010 and 2011 is likely to become jobless in 2012 and 2013.

Evan Soltas is a contributor to the Ticker. Follow him on Twitter.

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