- A vigilant Fed and higher real rates — As mentioned, the labor share of output may rise in coming years. But it is noteworthy that for all their tightness, labor markets have not yet driven a wage-price spiral, as evidenced by declining real wages in the US in 2022. This would seem to dispel comparisons between today’s inflation environment and what we witnessed during the 1970s. However, the Fed will certainly stay mindful of the possibility of a wage-price spiral and will not let up until it is convinced that disinflation has gained the upper hand. This means that even when it is done hiking rates, the Fed will remain vigilant until the inflation rate is closer to target and/or the unemployment rate turns up meaningfully. I would expect higher real policy rates over the course of the expansion.
Policy levers that can make a difference in a tight labor market
As a starting point for US policy, there may be a lot to learn from Japan, which grew its labor force over the past decade despite a rapidly shrinking working-age population. Among the tactics that proved effective: encouraging more women to enter the workforce by offering better, more affordable childcare, introducing flexible work arrangements, and removing disincentives such as a low retirement age. Addressing the cost of childcare, in particular, would move the needle in the US, where it tends to be far more expensive than in other parts of the developed world. The demand for solutions is so strong that it would not surprise me if, in the runup to the next US election, a renewal of the recently expired child tax credit ends up being endorsed by both parties (if it comes with a work requirement).
To the list of possible policy solutions, I would add improving elder care affordability and availability, expanding workforce training, and finding ways to bring those previously incarcerated or recovering from opioid addiction back into the labor market. Whatever the focus of the proposed solutions, careful policy design will be critical to ensure that workforce participation is incentivized.
Lastly, a greater willingness to open US borders to immigration could help mitigate the labor-market impact of an aging society. We saw an example when, after the COVID-driven hiatus in immigration, an influx of some one million immigrants helped ease the US labor supply/demand imbalance a bit. The importance of this incremental supply is visible in wage gains, which have started to moderate at the lowest end. For instance, immigrants account for 31% of the labor force in the hotel and lodging industry1, which saw some of the biggest wage increases in 2022 and some moderation recently. Looking ahead, the current backlog of 389,000 visas2 suggests room for another boost in immigration, which would be welcome news.
The relative scarcity of labor is likely to be an enduring theme given the shift in demographics, skill mismatches, and reshoring of supply chains. Going forward, I expect the focus to be on higher investment spending and higher real rates, as well as the possibility of more power ending up in the hands of workers. Policy likely needs to be more active in this area to find winning solutions.
Equity Market Outlook
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Andrew Heiskell
Nicolas Wylenzek