In our view, maximum employment probably declined as a result of the pandemic. We see several reasons for this:
- The pandemic has been a catalyst to a wave of retirements – by our calculations, based on Bureau of Labor Statistics data, around 25% of the decline in employment during the pandemic has been due to retirements.
- A pickup in migration from individuals and households able to work remotely could be reducing overall job matching efficiency. For example, the influx of people now living and working remotely outside of large urban areas means more demand for dining out, entertainment, and other services in those areas, which in turn are having difficulties finding workers for those jobs.
- The pandemic also could have been the catalyst to lifestyle or behavioral shifts that necessitate economic reallocation and create worker/job skills mismatches. Retail goods spending further shifting toward non-store (mainly online) outlets is one clear example.
- Finally, slower population growth due to fewer births per death could slow labor supply growth absent a pickup in immigration.
While the ultimate magnitude of the impact of each of these issues is highly uncertain (as are the improvements in maximum employment that are achievable through directed policy), we think the gap between actual and maximum employment is currently around 6.5 million. According to our forecasts, this figure could decline closer to a range of 2 million to 2.5 million by year-end, reducing the unemployment rate to an estimated 4.5%. Relative to January 2021, this represents about a 70% improvement in the employment situation, which, in our view, is a reasonable interpretation of substantial further progress.
The ‘what’ and the ‘how’
Details about what the tapering plan will look like – including the pace and timing for diminishing and ending purchases of U.S. Treasuries versus mortgage-backed securities (MBS) – should become clearer in the weeks and months ahead, potentially when the July meeting minutes are released. We expect the Fed to announce a roughly proportional reduction in the monthly pace of purchases of Treasuries and MBS, and for the monthly purchase pace step-downs to continue for around three quarters. While Fed policymakers will likely craft guidance to give themselves maximum flexibility to react to evolving economic conditions, we think the most likely scenario is a relatively smooth reduction in the pace, similar to the way the Fed wound down its portfolio starting in 2017. (For more details on our expectations for tapering, read our recent Viewpoint, “Fed’s Latest Shift Still Consistent With Policy Framework”.)
Turning to the last question of how the Fed plans to minimize market volatility around tapering, Chair Powell has stated the FOMC intends to communicate “well in advance” of the actual tapering announcement. The July FOMC statement changes stopped short of “advance notice.” However, we believe the statement did set the stage for advance notice to be given in September for a December tapering announcement. Nevertheless, because the FOMC has provided little additional information on when and how they will provide this notice, this is admittedly uncertain.
In any case, we hope to get more information on these and other issues over the next few months, as the FOMC prepares markets for the inevitable first step toward policy normalization.
