May 2022 / VIDEO
A Labor Demand and Supply Imbalance Challenges the Fed
Key Insights
- U.S. labor demand has considerably outpaced the supply of workers during the recovery from the pandemic-induced recession in 2020.
- This labor market tightness has contributed to upward pressure on wages and made the Fed’s task of taming inflation more difficult.
- The labor market may not be as tight as the headline unemployment rate makes it appear, as more workers can join the job market.
Transcript
U.S. labor demand has considerably outpaced the supply of workers during the recovery from the pandemic-induced recession in 2020. This has contributed to upward pressure on wages and made the Federal Reserve’s task of taming inflation even more difficult.
Job openings and vacancies have reached historically high levels during this recovery, and businesses have been consistently reporting difficulty in filling open positions. This imbalance between demand and supply is significantly worse than after the global financial crisis of 2008 and 2009.
During the previous recovery, the Fed allowed the labor market to run hot. This induced a gradual pickup in labor supply as more discouraged workers entered the labor force.
These trends eventually led to a cyclical rebound in the labor force participation rate in 2015 and 2016, which happened in spite of the demographic drag from aging baby boomers.
Back then, wage growth was modest, giving the Fed the room to be patient and let labor markets continue to strengthen. However, this recovery is shaping up quite differently.
At only 3.6% as of March, the official headline unemployment rate is below the Federal Open Market Committee’s long-run estimate, and it implies that the labor market is tight. This is partially because the recovery in the labor force participation rate has been more muted. A few factors are at play here: First, school closures and lack of childcare have kept some parents out of the labor force. Second, fear of COVID infection is keeping others on the sideline. And finally, some older workers are retiring early as their savings got a boost from the strong stock market performance of recent years, which was fairly strong.
But the Fed hopes that the labor market tightness can ease somewhat. As of March, government data showed that there were about 1.6 million fewer payroll employees than in February 2020, just before the onset of the pandemic. There were also about 5.6 million adults who were not in the labor force but wanted a job—this is 600,000 more than before the pandemic.
As a result of these workers on the sideline, the labor market may not be as tight as the headline unemployment rate makes it appear. So more workers can join the labor market to ease the demand/supply imbalance that we’re seeing.
But the Fed cannot be as patient now as it was before the pandemic. Wage inflation has accelerated, and it is rebounding faster than during the post-global financial crisis recovery.
There is now a public sense of urgency for the Fed to cool down labor demand in order to keep inflation under control. This is increasing the pressure on the central bank to expeditiously tighten monetary policy, as Fed Chair [Jerome] Powell put it himself.
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Blerina Uruçi is the chief U.S. economist in the Fixed Income Division. She contributes to the formulation of investment strategy and supports investment and client development activities throughout T. Rowe Price, specifically focusing on the outlook for the U.S. economy, inflation, and monetary policy. Blerina is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price Associates, Inc.