Everyday Economics: The U.S. economy is undergoing a structural shift

The Federal Reserve held interest rates steady last week. But borrowing costs remain elevated, making homes and cars less affordable. Meanwhile, higher energy prices are eroding purchasing power, and weak hiring is limiting workers' opportunities to change jobs.

The bond market's reaction suggests there's more to the story.

According to Treasury data, short-term yields fell while longer-term yields rose. Inflation-adjusted yields accounted for half the six-basis-point increase in 10-year yields and roughly 71% of the seven-basis-point increase at 30 years.

Higher real yields can signal stronger growth expectations, tighter monetary policy or greater compensation for risk. The market moves alone cannot tell us which.

But several major economic shifts are happening simultaneously, and their effects are becoming increasingly visible.

America is aging. Immigration and trade policies are reshaping labor supply and production costs. The U.S.-Iran war is pushing energy costs higher. And businesses are investing heavily in artificial intelligence, even as hiring remains weak.

Policymakers face difficult tradeoffs: interest rates can restrain demand, but cannot create workers, lower tariffs or produce more energy.

America's Demographic Shift

According to Federal Reserve researchers, aging and slower immigration could bring labor-force growth close to zero this year. The economy may need very few additional jobs to maintain stable unemployment.

Aging also changes the balance between production and consumption. Retirees generally work less, draw on savings and consume more healthcare services. When consumption remains strong while labor supply grows slowly, prices can face upward pressure.

A 2018 Bank for International Settlements study found that inflation has historically tended to be higher when a larger share of the population is too young or too old to work.

Globalization Is Changing

For decades, international trade helped businesses access cheaper inputs and more efficient supply chains.

Now, tariffs are raising import costs, immigration restrictions are constraining labor supply, and the U.S.-Iran war is disrupting energy markets.

According to the U.S. Energy Information Administration, Brent crude averaged $121 per barrel in the week ending Oct. 23, up roughly 70% from $71 before the U.S.-Iran war began in February.

The Bureau of Economic Analysis (BEA) data showed annual PCE inflation increased to 3.6% in September from 3.4% in August. Yet the GDP report shows prices rose at a 2.1% annualized pace in the third quarter, down from 5.0% in the second. That slowdown wasn't enough to lower annual inflation.

Meanwhile, the Bureau of Labor Statistics (BLS) reports private-sector wages rose 3.1% over the past year, but benefit costs increased 3.9%, including a 6.4% rise in health benefits. Total compensation growth barely slowed, to 3.4% from 3.5% a year earlier.

Inflation-adjusted private-sector wages fell 0.6% over the year. Workers' purchasing power is shrinking even as businesses face substantial compensation costs.

Economic Growth and Hiring Are Diverging

According to the BEA, real GDP grew at a 3.4% annualized rate in the third quarter. Underlying private domestic demand expanded 4.9%.

Yet according to BLS, employers added just 29,000 jobs in September, while unemployment edged up to 4.2%.

The labor market remains stable but fragile. According to BLS labor turnover data, the hiring rate was just 3.3% in August and the quits rate stood at 1.9%. Workers are staying put as job opportunities remain limited.

Slower labor-force growth helps explain low unemployment. Productivity may also explain why output is growing much faster than employment.

According to BLS, productivity increased 2.2% over the year through the second quarter, as output rose 2.5% with just 0.2% more hours worked.

Economist Gad Levanon argues AI may already be contributing to this divergence. The evidence is intriguing but not conclusive.

Investment Is Shifting

Business investment is supporting growth, though part of the third-quarter acceleration came from inventories, which can fluctuate considerably. Equipment investment also increased, led by computers and information-processing equipment, according to the BEA.

Construction spending reveals another shift.

According to the Census Bureau's August estimates, total construction spending declined 1.7% from a year earlier. Residential construction fell 4.8%, and manufacturing construction dropped 19.2%.

Yet office construction, which includes data centers, increased 24.6%, while power construction rose 8.5%.

As I reported in July, data-center construction is surging even as the factory construction boom fades.

AI could eventually expand production with fewer resources. But building that capacity requires energy, specialized workers, materials and capital, potentially adding to near-term cost pressures.

This week's productivity report, and especially Friday's jobs report, will offer another look at how these shifts are appearing in the data.

The policy mix matters. Tariffs and immigration restrictions can constrain supply and raise production costs. Meanwhile, the investment boom is creating additional demand for energy, materials, skilled labor and capital, potentially adding to near-term price pressures and keeping interest rates elevated. Technological advances, however, could expand future productive capacity.

For households, the stakes are high. If these forces keep inflation elevated, borrowing costs could remain high even as hiring slows, leaving families facing higher prices, fewer job opportunities and little relief on mortgages, auto loans and credit cards.

Can productivity growth expand America's productive capacity fast enough to offset the upward pressure on prices from these structural changes?