There's a reason why the job market doesn't feel like it's back to normal

Federal Reserve officials sometimes sound out of touch when they describe the labor market as having reached "full employment" when most Americans know full well the outlook for jobs is still far less rosy than before the Great Recession.

A new study published by the San Francisco Fed offers a window into one source of that disconnect - low labor force participation that reflects not only an aging population, but also a significant number of people who have technically but not actually "dropped out" of the labor force and are no longer counted. They still want a job, but are not actively looking in a formal sense because prospects became so dire.

The US labor force had already been shrinking for some time, but the decline accelerated during the downturn of 2007-2009. The San Fransico Fed's research tries to isolate the impact of demographic shifts such as an aging population on the jobless rate, thereby distinguishing it from the labor force effects.

"We find that the demographic-adjusted unemployment rate is still 0.3 to 0.4 percentage point higher than it was at past labor market peaks," write the study's authors, Regis Barchinon, a research advisor at the regional central bank and Geert Mesters of the Universitat Pompeu Fabra and the Barcelona Graduate School of Economics in Barcelona.

The findings are important for two reasons. First, the gap might seem small but potentially translates into hundreds of thousands more jobs. Second, the Fed is tightening monetary policy on the premise that, with the unemployment rate at 4.7%, job market conditions are becoming so tight they might soon spark inflation. Policymakers just raised interest rates for a second time in four months on March 15 and hinted at a few more hikes this year.

"The current low unemployment rate compared with previous labor market peaks has raised some fears regarding whether the labor market has become too tight," write Barchinon and Mesters. However, their numbers suggest "the labor market may not be quite as tight as the headline unemployment rate suggests."