In a recent blog post at the New York Federal Reserve Bank entitled “The Bathtub Model: The Importance of Labor Market Flow Dynamics,” the authors conclude that under certain conditions, the “unemployment rate will fall to close to 6 percent by early 2013.”

The conclusion is based on the inflows of Americans into unemployed status compared with the outflows into employment. As the economy recovers, the inflows slow and the outflows increase:

Economic downturns are typically characterized by short-lived spikes in the inflow rate followed by prolonged weakness in the outflow rate. The inflow rate plays an important role in the rise of the unemployment rate at the onset of recessions, but is typically less important in the decline of the unemployment rate during recoveries.

The authors run some scenarios to reach these conclusions:

First, the future path of the unemployment rate will be determined primarily by movements in the outflow rate. Second, flow dynamics suggest further declines in the unemployment rate. That is because even modest increases in the outflow rate can lead to significant declines in the unemployment rate as long as there is not a big negative shock that triggers a new wave of job losses. Finally, the unemployment rate can decline regardless of whether workers find jobs or leave the labor force, and thus can fall even in the absence of improved job-finding prospects.

In short, job creation is more important than anything else in bringing down unemployment. Given the authors’ results we can expect more of that, and the unemployment rate has nowhere to go by down.

Paul Ausick

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