Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Labor Force Participation Rate Is Plummeting Again
Transcript
- Lucas: So the labor force participation rate dropped again in June. It's now at 62.2 percent — that's the lowest reading outside of the pandemic era in data going back to the 1970s. Luna: Wait — that's with the unemployment rate falling to 4.2 percent? That seems contradictory. Lucas: Exactly. And that's what makes this such a confusing signal for the Fed. The headline payrolls number was only 57,000 jobs added in June — way below expectations. But the unemployment rate dropped because the labor force shrank — people stopped looking for work. Luna: So the unemployment rate goes down for the wrong reasons. Lucas: Right. The household survey showed employment actually fell by about 190,000. But because the labor force — the denominator — also shrank by more than 200,000, the unemployment rate ticked lower. This is the classic discouraged-worker dynamic. Luna: We've talked about this in past episodes, but the magnitude feels different this time. 62.2 percent — where does that rank historically? Lucas: You have to go back to the early 1970s to see sustained participation this low. And keep in mind: back then, women were entering the workforce in huge numbers, so participation was rising. Now we're seeing the opposite — a structural decline driven by aging demographics and, increasingly, what looks like labor force detachment among prime-age workers. Luna: Prime-age participation — that's 25 to 54 — is still fairly high, around 83.5 percent. So the drop is mostly older workers retiring and younger ones dropping out? Lucas: That's the conventional story. But look at the prime-age numbers more carefully: they've actually slipped about half a percentage point over the past year. That's a big deal. Prime-age participation is supposed to be stable. When it starts to dip, it suggests something beyond demographics — maybe long COVID, maybe caregiving burdens, maybe just a mismatch between available jobs and the skills workers have. Luna: And that mismatch shows up in JOLTS. Job openings actually ticked up in May to 7.6 million — that's still well above pre-pandemic levels. Lucas: Yeah, 7.6 million openings with only 7.6 million unemployed workers — that's a ratio of about 1.0. Usually, you'd expect more unemployed per opening when the labor market is cooling. But with participation falling, the pool of available workers is shrinking even as demand for labor remains relatively strong. Luna: So employers are stuck chasing fewer and fewer workers — which should push wages up. And yet average hourly earnings only rose 0.3 percent month over month in June, 3.9 percent year over year. That's not accelerating. Lucas: Right. That's the puzzle. If the labor market is truly tight, you'd expect faster wage growth. But we're not seeing it. One explanation: the composition of jobs being added is shifting toward lower-wage sectors like leisure and hospitality, which pulls down the average. Another: workers who are dropping out may be lower-skilled, so the remaining workforce has higher average productivity but slower wage growth. Luna: There's also the possibility that some of the participation drop is actually people going back to school or taking early retirement with the stock market at highs. The S&P 500 at 7,568 — that makes retirement portfolios look pretty good. Lucas: Absolutely. Wealth effect is real. If your 401 is up 20 percent in two years, you might decide to retire earlier than planned. And that's a structural loss to the labor force that isn't coming back. The Fed can't fix demographics. Luna: So what does this mean for the Fed? They're stuck at 3.63 percent on the effective federal funds rate. If participation keeps falling, does that argue for cutting rates to stimulate hiring? Lucas: Normally, falling participation would be a reason to cut — it means the economy has less supply capacity. But inflation is still sticky. Core PCE is at 2.6 percent year over year. The ten-year breakeven rate is only 2.23 percent, so markets expect inflation to stay near target, but the Fed wants to see more progress before easing. Luna: And they're worried about a wage-price spiral, even if it's not showing up yet in the data. Lucas: Exactly. The Fed is in a bind. They don't want to overstay and cause a recession, but they also don't want to cut prematurely and let inflation re-accelerate. With participation falling, the neutral rate of interest — R-star — might actually be higher than they think. Because a smaller labor force means the economy can grow faster without overheating, but it also means the same level of demand is more inflationary. Luna: So the participation drop could keep rates higher for longer, even if the labor market looks soft. Lucas: That's the uncomfortable conclusion. The market is pricing in a cut in September — but if participation keeps falling, the Fed might hold off. They'll want to see if the drop is cyclical or permanent. Luna: One more thing: the labor force participation rate for men aged 25 to 54 has been declining for decades. But for women, it had been rising until recently. Now even that is stalling. Lucas: Yeah, prime-age female participation peaked around 77.8 percent in early 2024. It's down about half a point since then. That's concerning because it suggests that the post-pandemic recovery in female participation — which was driven by remote work — may be fading as companies push for return to office. Luna: That's a really good point. The flexibility that brought women back into the workforce is being taken away, and we might be seeing the effects. Lucas: It's one of those stories that gets lost in the aggregate numbers. But it matters. If participation continues to drift lower, the Fed's job gets harder — and the economy's potential growth rate gets lower. Luna: You know, walking through the economy with you like this has really helped me make sense of these cross-currents. If it's doing the same for our listeners, I want to mention that listener support is what keeps this show ad-free and independent. Lucas: Yeah, it's a small thing but it makes a big difference. If you find value in these daily conversations, you can support the show at buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. Luna: And we mean it — every bit helps us keep the lights on and the data flowing. Now, let's get back to the participation puzzle, because there's another wrinkle I want to dig into. Lucas: Go for it. Luna: The prime-age participation decline — is it concentrated in any particular industry or region? I've seen some data that suggests it's worse in states with lower minimum wages and weaker social safety nets. Lucas: That's a great question. There is some geographic variation. Participation in the South and Mountain West has held up better, partly due to in-migration. But the Northeast and Midwest have seen larger drops. And industrially, it's concentrated in retail, hospitality, and construction — sectors that typically have lower wages and less flexibility. Luna: So it's a combination of factors: aging, wealth effects, lack of flexibility, and maybe even long-term health issues from COVID. Lucas: Right. And the worrying thing is that none of these factors are likely to reverse quickly. The Fed can cut rates, but that won't bring retirees back. It won't cure long COVID. It might encourage some prime-age workers to re-enter, but if the jobs being offered don't pay enough or offer the flexibility they want, they'll stay out. Luna: So what does the participation rate look like by the end of the year? If it stays at 62.2 or goes lower, that changes the whole economic outlook. Lucas: I think it drifts a bit lower — maybe to 62.0 by December. The demographic headwind is about 0.2 percentage points per year from aging alone. Add in discouraged workers and early retirements, and we could see another tenth or two. That would put the labor force at roughly 168 million, down from a peak of about 170 million in early 2024. Luna: That's a pretty big swing in a short time. And it means that even if hiring picks up, the unemployment rate could stay low simply because there aren't enough people looking. Lucas: Exactly. The Fed is going to have to parse a lot of noisy data. Falling unemployment could signal strength — or weakness, if it's driven by people dropping out. The participation rate is the most important piece of context, and it's the one that gets the least attention in the headlines. Luna: Speaking of headlines — we saw that China's consumer price growth weakened in June while producer inflation hit a four-year high. That's a whole different kind of imbalance. Lucas: Sure, but it reinforces a global theme: central banks everywhere are dealing with supply-side distortions that make traditional demand-management tools less effective. The Fed, the ECB, the People's Bank — they're all flying a bit blind. And a shrinking labor force in the U.S. is just one more layer of uncertainty. Luna: Alright, so to wrap up: participation is falling, and that's bad news for potential growth, tricky for the Fed, and it complicates the 'soft landing' narrative. What are you watching next? Lucas: I'm watching the weekly jobless claims — they came in at 215,000 for the week of July 4th, which is still very low. If claims start to rise above 250,000, that would signal layoffs are picking up. But for now, the story is about people leaving the workforce, not being fired. Luna: And that's a quieter, slower-moving problem — but maybe more persistent. Lucas: Exactly. We'll be tracking it all week. Thanks for listening.