Evolution of Behavior, Uncertainty, and the Difficulty of Predicting Labor Force Participation

Abstract

This paper demonstrates the difficulty of forecasting labor force participation (LFP) rates by showing that a random walk does just as well as select sophisticated econometric models in predicting short-term aggregate LFP. Most efforts to improve forecasts of LFP focus on fine-tuning predictions of determinants (i.e., demographics and labor market conditions). However, we show that even perfect knowledge of future demographic trends and labor market conditions is not enough to overcome the additional difficulty posed by changes in behavior over time. Behavior in this paper refers to the way in which demographics and labor market conditions impact labor supply decisions (i.e., parameter coefficients).