San Francisco Federal Reserve Reveals Labor Market's Lasting Inflationary Influence Despite Slowdown

Recent San Francisco Federal Reserve research points to persistent inflationary pressure from the U.S. labor market, even as it cools from its peak in 2022. In a Monday publication, economists Regis Barnichon and Adam Hale Shapiro highlighted that "elevated demand continued to contribute 0.3 to 0.4 percentage point to inflation as of September 2024." This insight underlines a nuanced understanding of the job market's influence on inflation despite a general slowdown. The analysis sheds light on the relationship between job openings, the ratio of job seekers, and inflation, as per Reuters.

In response to a decreasing inflation rate and a cooler job market, the U.S. central bank lowered its policy rate in September. Following a second rate cut earlier this month, the current range is 4.50%-4.75%. While Fed Chair Jerome Powell has suggested that labor demand and supply are now roughly in balance, not everyone at the Fed agrees on the current rate's restrictiveness or future rate adjustments. Powell pointed out that the decline in the job-openings-to-job-seeker ratio indicates that the job market is no longer a significant source of inflationary pressure. However, the recent San Francisco Fed findings, as reported by Reuters, suggest otherwise, with a notable ongoing impact on inflation rates.

Delving deeper into its framework, the San Francisco Fed's study considers three labor market indicators: the unemployment rate, the job vacancies to unemployed workers ratio (V–U ratio), and the vacancies to effective job seekers ratio (V–S ratio). These ratios are thought to better predict inflation by accounting for a broader set of available workers, including those not actively engaged in job searches. The research finds a decreased but still present impact of excess demand on inflation, contributing between 0.3 to 0.4 percentage points as of September 2024. It's a notable observation for policymakers, indicating a still-tight job market despite reduced inflation figures.

The San Francisco Fed researchers have pointed out that "excess demand peaked in the first quarter of 2022, contributing between 0.75 and 1.15 percentage points to inflation." While the economy has cooled, these persistent excess demand contributions mean inflation remains above the Federal Reserve's 2% target. According to findings shared by the Federal Reserve Bank of San Francisco, the V–S ratio, in particular, offers a superior forecast for inflation, emphasizing the value of including all effective job seekers in the analysis.