The U.S. economy is not going to return to “normal” anytime soon and won’t look the same as it did before the coronavirus pandemic, a senior Federal Reserve official says.
Esther George, president of the Federal Reserve Bank of Kansas City, said the pandemic will leave behind permanent changes in the economy. It might even significantly alter the manner in which the central bank sets U.S. interest rates.
” ‘Normal’ is likely to be elusive for some time,” George said in a virtual speech on Friday to the American Enterprise Institute think tank.
“The pandemic was a tremendous disruption that has affected every aspect of how and where people work, where they live, and what activities they engage in. Some of the changes coming out of the pandemic will persist and alter the structure of the economy.”
George pointed to a surprising shortage of labor that has developed in the U.S. even though millions of people who had jobs before the pandemic still haven’t gone back to work. If fewer people end up rejoining the labor force, she indicated, it’s unlikely that unemployment would return to a before-the-pandemic level of 3.5%.
She noted that many older workers who retired during the pandemic haven’t gone back to work and may never do so.
At the same time, a shortage of day-care workers could make it harder for some parents to resume working. Employment at day-care centers is still 10% below pre-pandemic levels, George said.
These labor shortages are playing a big role in the elevated inflation rate, particularly in the large service side of the economy. Companies have to pay higher wages, she said, and they are passing on the cost to customers.
While many of these problems are expected to fade once the pandemic wanes, George said some changes are certain to stick. And that will make it harder for the Fed to determine the level to which it should set U.S. interest rates.
The $8.5 trillion balance sheet the Fed has accumulated though massive bond purchases, George said, implies the Fed’s long-run target for interest rates should be higher than otherwise would be the case.
Alternatively, the Fed could downsize its balance sheet and set its long-range goal for a key U.S. interest rate at a somewhat lower level.
The central bank has pegged 2.5% as its long-run target.
“As the economy recovers from the pandemic shock, its path is likely to confound our assumptions about what a return to normal might look like. The same is true for the monetary-policy normalization process,” she said.
“Both point to a long and difficult process ahead as the economy heals and the stance of monetary policy responds,” she added.
George is not a voting member this year of the Fed’s 12-person committee that determines U.S. monetary policy. Yet she favors a drawdown of bond purchases, saying the “criteria for substantial further progress has been met.”
The Fed on Wednesday signaled it’s likely to announce the end of its bond buying soon, a process that could take six to eight months to complete.
The central bank has been buying $120 billion in Treasury bonds and mortgage-back securities monthly to keep interest rates ultralow.