Why lower interest rates may not fix America’s labor market?

The Federal Reserve’s current round of interest rate cuts are aimed at boosting employment, but experts say they may not be able to fix the imbalance in the labor market.

Federal Reserve officials have cut their benchmark interest rate by a quarter of a percentage point at each of their last meetings, and there is a chance they will do so again when they next meet in December. Central bankers hope that lower borrowing costs will stimulate the economy enough to prevent the recent slowdown in the labor market from worsening into a wave of unemployment.

Fed officials are divided on whether to cut interest rates to boost the labor market or keep them high longer to rein in inflation that has been above the Fed’s target of a 2% annual rate for five years. Some experts doubt that lower interest rates will help the labor market much.

“I don’t see the kinds of weakness that lower interest rates would actually help,” said Martin Eichenbaum, an economics professor at Northwestern University.

Job slowdown

The interest rate cuts are mainly in response to the worrying slowdown in job creation. The US economy added 22,000 jobs in August, the last month of available data, and actually lost jobs in June for the first time in four years. Before that, monthly job creation in the six figures was the norm.

But despite the slowdown, the unemployment rate has remained low due to fewer people entering the labor market. Fewer new jobs and fewer job seekers have left the labor market in what Federal Reserve Chairman Jerome Powell called a “strange equilibrium.”

Fed officials worry that the balance could quickly tip to a less interesting and more economically painful wave of layoffs. The labor force participation rate was 62.3% in August, a full percentage point lower than its pre-pandemic level.

There are several key factors behind the slowdown in labor supply and demand that have nothing to do with interest rates, including the country’s aging population, President Donald Trump’s crackdown on immigration, the adoption of artificial intelligence technology, and uncertainty over tariffs and trade policy.

Price cuts and car shopping

The Fed is following its tried-and-true playbook to save the economy from an impending slowdown.

The federal funds rate is lowered by the central bank, which controls the interest rate on loans that banks make to each other. This rate, in turn, affects borrowing costs for credit cards, auto loans, and other forms of credit. Lower rates encourage money to flow through the economy, as people can buy more goods and services. Businesses respond to increased demand by expanding production, which in turn requires hiring more workers.

“Citizen Joe goes to buy a car, and finds out his payments are going to be much lower. Well, he’s more likely to buy that car,” Eichenbaum said. “That will increase demand for production cars, people will be employed in the car industry, and then they will start spending, so you can see the cycle.”

Domestic breed

This is precisely why Fed Governor Christopher Waller said he supports cutting interest rates in December. In a speech this week at an economic conference in London, Waller said high borrowing costs prevent low- and middle-income households from making large purchases, such as cars.

“Most families face pressure to purchase large assets, such as housing and cars, partly due to expenses,” he said. He added: “I am concerned that restrictive monetary policy is impacting the economy, especially in terms of how it affects low- and middle-income consumers. The reduction in December will provide additional insurance against accelerating labor market weakness.”

In the most recent economic downturn caused by the pandemic, the Federal Reserve cut interest rates to near zero to boost the economy, and it worked: The job market came back strong after a wave of layoffs in 2020.

But what if this cycle short-circuits because there are fewer people entering the labor market?

“Car manufacturers can say, ‘Oh, we’re selling more stuff. Let’s hire more people. What if there is no one fit to hire? Eichenbaum said. “Suppose you can’t hire a good, skilled, blue-collar person to work in your factory because there’s none left. Well, you’re just raising the prices of cars, and people are competing with each other to get those rare cars.”

This is how low interest rates can lead to inflation instead of jobs.

Fed officials are aware of the risks, and the Federal Open Market Committee, the Fed’s decision-making body, has opposed cutting interest rates for this reason.

It is unclear which side will prevail. On Tuesday, financial markets were anticipating a 51% chance of a rate cut in December, according to CME Group’s FedWatch tool, which forecasts interest rate movements based on federal funds futures trading data.

“I think it’s hard to make a compelling case for lowering interest rates now, and I think that’s partly why they’re so divided,” Eichenbaum said.