Federal Reserve officials hope that the central bank’s aggressive money printing policies will help the economy return to pre-pandemic health.
But policymakers are coming around to the view that a damaged labor market may not be able to quickly return to early 2020 levels, when the unemployment rate sat at a historic 50-year low.
“We don’t want to lose track of that because that tells us the economy that we had,” New York Fed President John Williams told reporters on Monday. “Can we get exactly to that economy in a year or two? I’m not sure.”
The concern: that those deciding to retire during the pandemic will not return to the labor force. Other factors, such as migration in or out of certain geographic regions, may also present challenges in filling the over 9 million job vacancies.
“I’m not necessarily expecting every indicator to get back to where it was, but I would like to see us get back farther than we’ve come,” Cleveland Fed President Loretta Mester told reporters on Tuesday.
The tone of Fed commentary over the last week was a noticeable downshift from optimism earlier in the year that the labor market would be able to bounce back quicker.
In April, Fed Chairman Jerome Powell said labor market scarring did not appear to be as bad as originally thought. He pointed to an encouraging March jobs report as a sign that the economy could see more months of 1 million job gains.
Two weaker-than-expected job reports for April and May showed the pace of job gains was actually closer to 500,000 a month.
“We don't actually know exactly what labor force participation will be as we go forward,” Powell said on June 16.
In February 2020, the labor force participation rate was 63.3% and slightly trending up. The pandemic caused that rate to crater in April 2020 before bouncing back, but recent figures have shown the labor force participation rate plateauing at just under 62%.
Goldman Sachs estimates that early retirements during COVID have depressed the labor force participation rate by about 0.5 percentage points, which the bank's economic team says "will likely prove permanent."
Implications for policy
At the moment, the policy-setting Federal Open Market Committee is still providing its aggressive monetary support to the economy, in the form of near zero short-term borrowing rates. The Fed is also buying up about $120 billion a month in U.S. Treasuries and agency mortgage-backed securities.
But with inflationary pressures raising concern that price increases could prove to be more persistent than expected, some Fed officials are expressing eagerness to begin pulling back its accommodations.
St. Louis Fed President James Bullard and Atlanta Fed President Raphael Bostic are among the Fed officials who see the case for the first post-COVID interest rate hike by the end of 2022.
Bostic told reporters Wednesday that he also penciled in two additional rate hikes in 2023, although he cautioned that “much is going to happen between now and then that could shift my thinking.”
But with 7.6 million workers still out of the labor force compared to pre-pandemic levels, Minneapolis Fed President Neel Kashkari told Reuters that he was not “ready to write [the unemployed] off” and advocated for keeping interest rates at near zero through 2023.
Other Fed officials have said policy would still be largely supportive even after slowing, or “tapering,” the pace of its asset purchases. In December 2020, the Fed said it would begin that process when the recovery showed signs of making “substantial further progress,” a discussion that the Fed expects to ramp up in coming months.
“Do I want [the labor market] to go all the way back before I would do anything on the taper? Probably not. We just need to see substantial further progress,” Mester said Tuesday.
With inflationary pressures rising, the U.S. economy is now testing the resolve of the Fed’s new framework, which last year changed its language to prioritize assessments of “shortfalls of employment from its maximum level.”
With the pandemic threatening longer-term damage to the labor market, the Fed will have to grapple with what “shortfall” means.
Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.
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