Abstract
Understanding whether labor market developments stem from supply or demand forces has fundamental implications for the conduct of monetary policy. This article develops a structural vector autoregression (VAR) methodology to decompose U.S. employment and wage growth into supply and demand components using sign restrictions. Extending Shapiro 2026, we separately identify trend growth, current shocks, and past shocks across different industries. Results reveal that goods-producing sectors experienced strong demand-driven growth in 2022, which subsequently weakened as Federal Reserve tightening took effect. Service sectors showed robust demand through 2023, but by 2025, supply-side factors—likely due to immigration policy changes—became dominant. We validate our shock identification by linking estimated demand shocks to financial dependence measures during monetary tightening and supply shocks to immigration flows. These findings highlight the asymmetric nature of post-pandemic labor market rebalancing and underscore the importance of distinguishing supply from demand forces for appropriate monetary policy calibration.
Introduction
In early 2020, at the onset of the pandemic, the U.S. economy experienced a sharp downturn in the labor market. Shortly after, the labor market demonstrated remarkable resilience and strength. Important changes in consumers’ demand, away from services and toward goods, coupled with high levels of disposable income, led to a period of consumer price inflation, wage growth, important levels of labor market turnover, and labor reallocation across sectors.
The drivers behind this labor market performance remain a subject of debate among economists and policymakers. Understanding whether wage and employment growth stem from supply-side or demand-side factors has critical implications for policy design and economic forecasting. The 2022-25 period offers a particularly valuable window for this analysis.
