Why the Benchmark Moves: Demography, Policy, Productivity, and Uncertainty

This chapter traces the supply-side forces that can move a sustainable unemployment benchmark even when the way unemployment is measured has not changed. The CBO’s outlook is useful here because it connects the noncyclical rate to a wider production system: population, participation, labor demand, capital, productivity, and policy. Following those connections helps explain why a number such as 4 percent cannot be carried from one period into another as though the economy’s capacity were fixed.

The supply-side components of a moving benchmark

A benchmark built from sustainable capacity has several interacting components. The first is the potential labor force: the people who would be working or seeking work if output and other key variables were at their maximum sustainable amounts. The second is participation, which determines how much of the working-age population enters that labor force. The third is labor demand, which determines how many workers firms can profitably employ given output, wages, technology, and expected sales. Potential output adds capital and productivity to the picture.

These components do not move in lockstep. A change that reduces the number of available workers can reduce potential output over the long run, but it can also create shortages in particular occupations and put upward pressure on wages in the short run. A policy that raises incentives to work can increase participation, but its effects may arrive alongside changes in taxes, demand, or the cost of living. A productivity improvement can allow more output with the same workforce, while a trade disruption can make existing capital and imported inputs less efficient. The noncyclical unemployment rate is the aggregate result of these interacting conditions, not a dial controlled by one variable.

Demography is the clearest example. The CBO projects slower labor-force growth from 2026 to 2036 than in the decade before the pandemic, averaging about 0.4 percent annually rather than about 0.7 percent. The agency attributes much of the slowdown to population aging and lower net immigration. As members of older generations retire, the share of the population in age groups with high participation changes. The overall labor-force participation rate is projected to decline from 62.5 percent in 2025 to 61.9 percent in 2036.

A smaller labor force does not translate mechanically into a lower unemployment rate. The unemployment rate is a ratio involving people in the labor force, and the effect of a smaller labor supply depends on what happens to employment and demand. If firms continue to seek workers while fewer people are available, some parts of the labor market can become tighter. If a smaller population also reduces demand for goods, services, and housing, firms may need fewer workers. The CBO’s revised demographic outlook emphasizes this second channel: weaker aggregate demand and lower potential output can lead to sluggish labor demand, slightly raising the noncyclical component of unemployment even as worker shortages create pressure in some sectors.