Why Lower Interest Rates May Not Fix America’s Job Market

The Federal Reserve’s current round of interest rate cuts is meant to boost hiring, but experts say they may not be able to fix what’s wrong with the job market.

The Federal Reserve officials cut their benchmark interest rate by a quarter of a percentage point at each of their last two meetings, and there’s a chance they’ll do it again when they next meet in December. Central bankers hope lowering borrowing costs will gas up the economy just enough to prevent the recent job market slowdown from worsening into a surge of unemployment.

Fed officials are divided about whether to cut rates to boost the job market or to keep them higher for longer to restrain inflation that has been above the Fed’s target of a 2% annual rate for five years. And some experts are skeptical that lower interest rates will even help the job market all that much.

“I don’t see the types of weaknesses that interest rate cuts are really going to help,” said Martin Eichenbaum, professor of economics at Northwestern University.

The Jobs Slowdown

The rate cuts are mainly in response to an alarming slowdown in job creation. The U.S. economy added 22,000 jobs in August, the last month of available data, and actually lost jobs in June for the first time in four years. Before that, monthly job creation in the six figures was the norm.

Despite the slowdown, however, the unemployment rate has stayed low because fewer people are entering the workforce. Fewer new jobs and fewer new job-seekers have left the labor market in what Fed Chair Jerome Powell described as a “curious balance.”

Fed officials worry that the balance could quickly topple into a less curious and more economically painful wave of layoffs. The labor force participation rate was at 62.3% in August, a full percentage point below its pre-pandemic level.

Several major factors behind the slowdown in both supply and demand for labor have nothing to do with interest rates, including the nation’s aging population, President Donald Trump’s crackdown on immigration, the adoption of artificial intelligence technology, and uncertainty about tariffs and trade policy.

Rate Cuts And Car Shopping

The Fed is following a tried-and-true playbook for rescuing the economy from an impending slowdown.

The central bank is lowering the fed funds rate, which controls the interest rate on loans that banks make to one another. That rate, in turn, influences borrowing costs for credit cards, car loans, and other forms of credit. Lower rates encourage money to flow through the economy, as people can afford more goods and services. Companies respond to increased demand by expanding production, which in turn requires hiring more workers.

“Citizen Joe goes in to buy a car, and he finds out his or her payments are going to be a lot lower. Well, he or she is much more likely to buy that car,” Eichenbaum said. “That’s going to boost demand for cars for production, and folks are going to be hired in the auto industry, and then they start to spend, so you can see a cycle.”

Household Strain

That’s exactly why Fed Governor Christoper Waller said he supports a rate cut in December. In a speech this week at an economic conference in London, Waller said high borrowing costs were preventing low- and middle-income families from making large purchases, such as cars.

“Most households are facing strains in purchasing large assets, such as housing and autos, in part because of the expense,” he said. “I worry that restrictive monetary policy is weighing on the economy, especially about how it is affecting lower-and middle-income consumers. A December cut will provide additional insurance against an acceleration in the weakening of the labor market.”

In the most recent economic downturn caused by the pandemic, the Fed cut rates to near zero to boost the economy, and it worked: the job market came back with a vengeance after the wave of layoffs in 2020.

But what if that cycle is short-circuited because there are fewer people entering the workforce?

“Car manufacturers, they can say, ‘Oh, we’re selling more stuff. Let’s hire some more people.’ What if there’s nobody decent to hire?” Eichenbaum said. “Suppose you can’t get a particularly good, skilled blue-collar guy to work in your factory because there are none of them left. Well, then you just kind of raise the price of cars, and people bid with each other to get those scarce cars.”

That’s how lower rates could produce inflation instead of jobs.

Fed officials are aware of the risk, and a contingent of the Federal Open Market Committee, the Fed’s policymaking body, has argued against cutting rates for that reason.

It’s unclear which side will prevail. On Tuesday, financial markets were pricing in a 51% chance of a December rate cut, according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data.

“I think it’s a tough case to make an overwhelming argument for lower interest rates now, and I think that’s partly why they’re so divided,” Eichenbaum said.