People talk about the Federal Reserve setting interest rates, but it is a Fed committee, the Federal Open Market Committee, that does that. It meets periodically for two days, and its decisions impact the economy in the U.S. and around the world.
The global financial markets pause for a bit on the afternoon of the second day, a Wednesday, to wait for the FOMC’s decision. In September, it decided to leave rates unchanged. The next meeting is Oct. 31- Nov. 1. The smart money is betting that the FOMC will again leave rates alone, but that is some three weeks away, which in this economy is a long time. There’s a lot of data coming out between now and then, like the September consumer price index Thursday morning.
The FOMC is composed of members of the Federal Reserve Board of Governors, the New York Fed president, and a rotating cast of other regional Federal Reserve bank presidents.
Thomas Barkin is president of the Federal Reserve Bank of Richmond, and this year he has been an alternate member of the FOMC. In January, he will be a voting member again.
That was reason enough for me to go to Wilmington to hear him give a speech last week at the UNC Wilmington economic outlook conference. But he also has interesting things to say about the economy, because he supplements his own opinions by traveling around and talking to business folks in the Fifth District, which has a footprint from South Carolina to Maryland and over to West Virginia. North Carolina is the most populous state in the district and has the largest economy.
Thursday, he was at the Wilmington Convention Center talking about the economy, the labor market, and inflation.
The economy, he said, has been “incredibly resilient.” He cited a new S&P Global estimate that GDP grew 5.1% on an annualized basis in the third quarter, well above 2.1% in Q2. That’s despite the FOMC raising its target interest rate 11 times since March 2022 to slow down inflation.
“This growth has been in no small part due to the consumer, who has continued to spend down pandemic-era savings, the benefits from higher wages, and also rising equity in house valuations,” he said.
The unemployment rate remained at 3.8% in September, and the jobs report Friday — the day after Barkin’s speech — was a blowout 336,000 number for September, continuing to stretch a tight labor market.
Despite that, “inflation has started to settle,” said Barkin. The Fed’s preferred inflation metric, the Personal Consumption Expenditures price index, came in at 3.5%, year over year, for August, around half what it was in June ‘22. Core PCE, ex-food and energy, was 3.9%, which is still well above the Fed’s target of 2% inflation.
There is a debate right now between those who think inflation is going to keep dropping “without much additional erosion of demand,” and those “who believe the fight against inflation is going to require a more significant slowdown.”
“And I believe,” said Barkin, “that the answer to which of those is the right path depends on what happens in the labor market.”
And that is hard to predict, both in the short and long run. There are a lot of cross-currents, and Barkin discussed some of them.
Everywhere he goes, he hears about labor shortages. But, he said, hiring is easier than it was a year ago. The Great Resignation has “largely passed, particularly for professionals.” People are slowly going back to the workforce.
“But easier and better isn’t the same thing as normal,” he acknowledged. In February 2020, 61.1% of the population was employed. Today, it is 60.4%. That represents 2 million fewer workers. Meanwhile, the economy has grown 6% since before the pandemic. That helps explain why labor seems short, Barkin said.
Some of this was expected, as Baby Boomers aged. “But the rest of the gap is almost entirely attributable to the lower participation rate for those at or near retirement age.”
For decades, our economy got used to a growing labor force: Plenty of Baby Boomers, women entering the workforce in greater numbers, improved health that enabled longer careers, as well as historically high levels of immigration.
“And all this was supplemented by access to ever-growing, low-cost offshore labor,” he said. “But those tailwinds look like they’re changing and they’re becoming headwinds.” Fertility rates have fallen for years, meaning fewer younger workers to replace retiring ones. K-12 enrollment is predicted to drop nearly 8% over the next decade. Immigration policy, said Barkin, “looks unlikely to materially change any time soon. And offshoring has been complicated by increased awareness of the risks associated with dependence on foreign labor sources.”
During the pandemic, as employers faced labor shortages, companies didn’t sit still, said Barkin. “Employers that found themselves short offered big perks or higher wages to convince workers to come,” particularly in leisure and hospitality. This has created some unusual situations, like the Bojangles in South Carolina that was attracting workers from a manufacturer Barkin talked to. “Their pay had gone up a little. Bojangles’ pay had gone up a lot.” But it wasn’t just pay. Working conditions that require last-minute overtime or challenging physical labor “require more of a premium now.”
Employers are trying other strategies beyond pay. They are trying to increase the pool of workers with training partnerships with community colleges, apprenticeships and internships. “That’s good for workers. That’s good for growth. That’s good for reducing inflation,” Barkin said.
But they are also looking at automation and artificial intelligence, basically investments to reduce demand for labor. He cited a McKinsey study that estimated that automation – including AI – could replace 30% of the hours worked in the U.S. by 2030. “While there’s a lot of buzz about it, it is not going to happen overnight.”
The upshot is that “The range of potential outcomes to me is still pretty broad.”
Maybe the labor supply will expand with training programs and bored or financially squeezed retirees coming back to work. Maybe labor demand will drop as automation rolls out or the economy weakens. Maybe employees will moderate wage requirements back to pre-Covid levels. Or maybe employers will continue to raise wages and try to pass on price increases to pay for them.
“You could articulate a case for resurgence. You could articulate the case for a slowdown. You could articulate the case for a return to a pre-Covid economy,” said Barkin. “And the breadth of those scenarios is why I was very comfortable supporting our decision at the last meeting to hold rates steady. We have time to see if we’ve done enough or whether there’s more work to do.”
“The path forward, to me, depends on whether we can convince ourselves inflation pressures are behind us, or whether we see them persisting. And I’ll be watching the labor market closely for those signals.”
