At least some of the decline in labor force participation that has concerned the Federal Reserve may be cyclical, but it could take some years for that rate to bounce back, San Francisco Federal Reserve Bank economists find in a paper released Monday.

The fact that labor force participation has failed to increase thus far is probably because of the slowness of the current recovery compared to past recoveries, the three San Francisco Fed economists who authored the paper find.

The labor force participation rate is one of a number of indicators the Fed's policymaking Federal Open Market Committee is watching closely as it seeks to bring about "substantial" improvement in the outlook for the labor market before it halts or scales back its large-scale asset purchases.

The labor force participation rate - essentially the percentage of the working population that is either working or looking for work - now stands at 63.3%. That compares to 66% as recently as mid-2008.

Taking note of the large number of "discouraged" workers and others who have left the labor force at his last press conference, Fed Chairman Ben Bernanke said some of the downtrend has been due to demographic factors, but commented that "as the economy strengthens, the labor market strengthens, I would expect to see some of these folks coming back into the labor force."

"For example, the number of people who are out of the labor force but say they would like a full-time job and are not actually counted as unemployment," Bernanke continued. "That number has been going up, which suggests there are more people thinking about going back, in the labor force, going back to work."

"But I doubt that in the near term at least that we will see an increase in labor force participation, because besides the effects of the slow recovery, high unemployment, we have had a downward trend in the U.S. which is not due to the recession," he added.

One complicating factor for Bernanke and his fellow policymakers is that, if and when the labor force participation rate rises, the number of monthly job gains needed to bring down the unemployment rate will also rise.

Atlanta Fed director of research David Altig, who spoke recently with MNI, calculates that at a 63.5% labor force participation rate, it would take roughly two years to reach a 6.5% unemployment rate - the FOMC's threshold for considering increases in the federal funds rate - if payroll gains average 180,000 per month.

However, if the labor force participation rate increases, as it typically does in a strengthening recovery, the requisite number of monthly jobs would also grow. If the labor force participation rate rose to 64.5%, it would take more than 271,000 new jobs per month to achieve 6.5% unemployment in two years. If the labor force participation rate got back up to the previous 66%, it would take nearly 409,000 jobs per month to get to a 6.5% unemployment rate over the same time frame.

In the first four months of 2013, nonfarm payrolls have averaged around 196,000.

The San Francisco Fed researchers - Leila Bengali, Mary Daly and Rob Valetta - do not venture into monetary policy territory, but their findings, based on cross-state comparisons, have bearing on an issue that the Fed is watching closely.

"The largest declines have occurred in states with the largest job losses," they write. "This suggests that some of the recent drop in the national labor force participation rate could be cyclical."

The San Francisco Fed economists acknowledge that there has been a downtrend in labor force participation since roughly 2000, brought about by such factors as "the baby boom cohort moving past their prime working-age years; the stabilization of women's labor force participation rates; more younger working-age people enrolling in school, and increased use of some social benefit  programs, notably disability insurance."

However, they say demographic factors alone can't explain the "sharp" decline since 2007. "The recent withdrawal of prime-age workers from the labor market is unprecedented and may reflect a cyclical component that could reverse as the labor market recovery solidifies."

Based on their study of state jobs data, Bengali, Daly and Valetta find that "larger declines in employment are associated with larger declines in labor force participation rates. This systematic relationship at the state level between the severity of employment losses and the decline in participation suggests that the drop in the national participation rate may also have an important cyclical component."

But why hasn't the recovery since the recession officially ended in June 2009 brought about more of an increase in labor force participation if it is, indeed, partially cyclical?

The San Francisco Fed researchers answer that question by saying, "the current weak correlation between changes in employment and labor force participation could reflect employment's relatively modest recovery to date."

"The economy has been expanding for a sustained period," they grant. "But, as of March 2013, we have recovered only 67% of total jobs lost during the downturn. Thirty-seven months after the employment trough in past recoveries, employment greatly exceeded the pre-recession peak."

The economists note that in previous recoveries, labor force participation did not begin increasing "until the economy had passed the previous employment peak by a substantial margin."

They say "labor force participation at the state and national levels may bounce back or decline less rapidly as the current recovery gains strength."

However, given low prevailing levels of employment relative to the recession trough, they conclude that "in the current recovery, it will probably take a few years before cyclical components put significant upward pressure on the participation rate because payroll employment is still well below its pre-recession peak."

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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