The initial concern is that the fall in the participation rate after the COVID-19 crisis will lead to pressure on the labour market, and therefore an acceleration in wages, higher inflation and higher interest rates. But it should be remembered that central banks’ contemporary objective is to drive up the employment rate. When the participation rate falls, they respond with a more expansionary monetary policy to drive it up, not a more restrictive one, as analysts at Natixis note.
The link between participation rates and monetary policy in the US
“The current concern is as follows: After the COVID-19 crisis, the participation rate has fallen sharply in the US; workers who lost their jobs have not returned to the labour market. This has led to pressure on the labour market, with hiring difficulties for companies. And the risk is then an acceleration in wages, which is not visible at present, and which would give rise to a lasting rise in core inflation and in interest rates. The risk would then obviously be that of a public and private debt crisis, a drastic fall in share prices and real estate prices, and a fall in investment.”
“Already from 2016 to 2019, the Federal Reserve pursued overheating: the aim is to maintain an expansionary monetary policy, with interest rates significantly lower than growth even though the unemployment rate is already low): the objective is then to drive up the participation rate (which was the case between 2016 and 2019) by encouraging companies to hire low-skilled employees, and by encouraging those who have left the labour market to return to it. The overheating policy then aims to lift the participation rate, which naturally falls after recessions, due to job and skills losses. And that policy was successful from 2016 to 2019.”
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