Why Rate Cuts Won't Fix a Labor Supply Shock
Interest rate cuts won't relieve a labor supply shock: with lessons from energy and housing crises.
After today's stunning job revision of -911,000 jobs for March 2025, the stock market rallied. The S&P index is hitting all time highs, as it has been over the past two weeks. That might seem like a contradiction, but it's because the BLS data is used to guide the decisions of the Federal Open Market Committee in raising or lowering the interest rate. A bad jobs report will push the FOMC into lowering rates.
Lower interest rates make it cheaper to borrow money across all sectors of the economy. This makes companies more likely to expand and therefore hire more workers. That's the thinking on how rate cuts counteract a bad labor market. But there's a problem with how this applies to the current macro environment.
Think like a company. Just because it's cheaper to borrow money doesn't it mean make sense for to take on new ventures. If there's nobody to hire, then it doesn't matter how much money you have. Monetary policy is fundamentally a demand-side policy.
Retiring boomers, decreased immigration, and general uncertainty over federal policy have made companies cautious in taking risks dependent on labor.
The same situation happened in the 1970s during the energy crisis. When geopolitical instability caused supply shocks in oil, the US economy entered "stagflation", where both inflation and unemployment were increasing. The only solution was the "Volcker shock", when Fed Reserve head Paul Volcker sharply rose interest rates from 11.2% to 20% in order to crush the runaway inflation with a recession.
And last year, despite rate cuts of a total 1%, interest rates on mortgages remained high, increasing from a high 6% to 7.1%. Typically, mortgage rates decrease when the Fed Funds rate does, as lenders try to attract new business with lower rates while existing homeowners refinance at lower rates. But the supply constraints caused by slowdowns in building homes meant that even if it was cheap to buy a home, people wouldn't be able to find one.
With the increased media scrutiny on the Federal Reserve, along with the president's statements about them, their decisions matter more than ever. On September 17, we will see whether they cave to these expectations.