Welcome to Thoughts on the Market. I’m Michael Gapen, Morgan Stanley’s Chief U.S. Economist. Today I’ll talk about the way restrictive immigration policies could potentially slow U.S. economic growth, push up inflation, and impact labor markets.
It’s Wednesday, February 26th, at 2 PM in New York.
Lately, investors have been focused on the twists and turns of Trump’s tariffs. Several of my colleagues have discussed the issue of tariffs from various angles on this show. But we think the new administration’s immigration policy deserves more attention.
Immigration is more than just the entry of foreign citizens into the U.S. for residency. It's a complex process with significant implications for our economy. According to the Bureau of Labor Statistics, as of June 2024, 19 percent of the US workforce was made up of immigrants – which is over 32 million people. This is a significant increase from 1994, when only about 10 percent of the workforce was foreign-born. Immigrants tend to be employed in sectors like agriculture, construction and manufacturing, but also in face-to-face services sectors like retail, restaurants, hotels and healthcare.
Immigration surged to about 3 million per year after the pandemic. In fact, immigration rates in 2022 to 2024 were more than twice the historical run rate. This surge helped the US economy to "soft land" following a period of high inflation. It boosted both the supply side and the demand side of the U.S. economy. Labor force growth outpaced employment, which helped to moderate wage and price pressures.
However, Trump’s policymakers are changing the rules rapidly and reversing the immigration narrative. Already by the second half of 2024, border flows were slowing significantly based on the lagged effects of steps previously taken by the Biden administration. Under the new administration, news reports suggest immigration has slowed to near zero in recent weeks.
In our 2025 year-ahead outlook, we noted that restrictive immigration policies were a key factor in our prediction for slower growth and firmer inflation. We estimate that immigration will slow from 2.7 million last year to about 1 million this year and 500,000 next year. The recent data suggests immigration may slow every more forcefully than we expect.
If immigration slows broadly in line as we predict, the result will be that population growth in 2025 will be about 4/10ths of 1 percent. That’s less than half of what the U.S. economy saw in 2024. The impact of slower immigration on labor force measures should be visible over time. For the moment though, there is enough noise in monthly payrolls and the unemployment rate to mask some of the labor force effects. But over three or six months, the impact of slower immigration should become clearer.
In terms of economic growth, if immigration falls back to 1 million this year and 500,000 next year, this could reduce the rate of GDP growth by about a-half a percentage point this year and maybe even more next year, and put upward pressure on inflation, particularly in services, and to some extent overall wages. Slower immigration could pull short-run potential GDP growth down from the 2.5-3.0 percent that we saw in recent years to 2 percent this year, and 1-1.5 percent next year.
On the other hand, the unemployment rate might fall modestly as immigration controls reduce the number of households with high participation rates and low spending capacity. This could lead to tighter labor markets, moderately faster wage growth, and upward pressure on inflation. So we think we are looking at a two-speed labor market. Slower employment growth will feel soft and sluggish. But a low unemployment rate suggests the labor market itself is still tight.
Given all of this, we think more restrictive immigration policies could lead to tighter monetary policy and keep the Fed on its currently restrictive stance for longer. All of this supports our expectation of just one cut this year and further rate cuts only next year after growth slows.
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