WASHINGTON -- A growing number of Americans quitting the labor force are likely gone for good, offering a cautionary note to the Federal Reserve as it tries to gauge how tight the job market is and how quickly to raise interest rates.
For a long time, data suggested a significant portion of the decrease in labor force participation was because many job seekers had grown frustrated with their search and had given up looking. If the job market tightened enough, the thinking went, these Americans would be lured back to hunt for work again.
But a different picture is now emerging. Data shows participation in the past few years has fallen mainly because Americans have retired or signed up for disability benefits.
"The data suggest that the recent exits from the labor force have been more voluntary in nature than was the case in 2009, when the economy was weak and job prospects were dire," said Omair Sharif, senior economist at RBS in Stamford, Conn.
According to economists who have analyzed Labor Department data, 6.6 million people exited the workforce from 2010 and 2013. About 61 percent of these dropouts were retirees, more than double the previous three years' share.
People dropping out because of disability accounted for 28 percent, also up significantly from 2007-2010. Of those remaining, 7 percent were heading to school, while the other 4 percent left for other reasons.
In contrast, between 2007 and 2010, retirees made up a quarter of the six million people who left the labor force, while 18 percent were classified as disabled. About 57 percent were either in school or otherwise on the sidelines.
"This suggests the current drop in the labor force is more structural in nature," said Sharif.
If so, there is less hope of luring people back to hunt for work as the job market tightens, as many Fed officials believed would be the case. And the U.S. central bank, which has held benchmark rates near zero since December 2008, will likely need to push them up sooner than they would have otherwise.
"It is not clear whether the overall participation rate will increase anytime soon, given that the underlying downward trend due to retirements is likely to continue," said Shigeru Fujita, an economist at the Federal Reserve Bank of Philadelphia.
Less Labor Market Slack
Some Fed policymakers, such as San Francisco Fed President John Williams, are starting to acknowledge that structural factors are playing a big role in the labor force's decline.
In a speech last month, Williams said the slack in the labor market could be "much less than assumed," cautioning that inflation could rise more quickly than currently anticipated.
There are people who aren't in the labor force who say they want a job and who could potentially be drawn back in.
Last year that figure stood about 700,000 higher than it would in a normal market, according to the Labor Department's survey of households. But if employment increased by about 115,000 jobs a month, as the survey found it did last year, they could easily be absorbed in about six months.
The disappearing slack is underscored by a sharp decline in the ranks of the short-term unemployed.
These workers, whose skills are still sharp, are viewed as the most desirable by employers, economists say. Further, they appear to hunt for work more aggressively, according to a study released last week by former White House economist Alan Krueger.
In contrast, long-term unemployed can see their skills erode
and lose contact with people who could help them find a job. Because employers find them less desirable, their presence in the labor market may not do much to keep wages down.
The unemployment rate for people out of work for six months or less was at 4.2 percent in February, well below its 5.2 percent post-recession average. The number of short-term unemployed workers is now at about the same level as in 2004.
As for the long-term jobless, their ranks are still more than double their 2004 level.
Some economists say the dwindling pool of attractive workers may already be leading employers to bid wages up. Average hourly earnings for production and nonsupervisory workers notched their biggest gain in four years in February, even as some broader measures showed little acceleration.
"With the short-term unemployment rate already back to its pre-crisis level, any further declines will put upward pressure on wages and ultimately inflation," said Torsten Slok, chief international economist at Deutsche Bank Securities in New York.
"For the Fed, the problem is we are still having a fed funds rate which is zero. I think the Fed will start to change its tone, most likely in the second half of this year."