FED FOCUS-Labor supply debated as slower output looms

By Tamawa Kadoya

CHATHAM, Mass., June 20 (Reuters) - A steady decline in the U.S. working-age population as baby boomers retire may significantly reduce potential economic output, requiring new rules of thumb to guide the Federal Reserve as it seeks to keep inflation at bay.

But the pace at which labor supply growth will slow is far from clear, as debate at a conference hosted by the Boston Federal Reserve Bank this week showed, and the Fed faces a tough task as it seeks to properly calibrate interest rates.

The outlook may be dire. A paper presented by Bruce Fallick of the Federal Reserve Board and Jonathan Pingle at Brevan Howard Asset Management showed the projected population aging will lower the aggregate labor force participation rate by 6 full percentage points over the next 35 years.

The participation rate, the proportion of the working-age population in the labor force, peaked in the late 1990s after about a half-century of gains. It stood at 66 percent in May and many analysts expect it to gradually trend lower.

"The implication of this for monetary policy is that potential output would be much less, holding everything else constant," said Lisa Lynch, economics professor at Tufts University, who is also chair of directors at the Boston Fed.

Fed officials are already struggling with this emerging reality, searching for fresh benchmarks for the economy's new and downwardly shifting noninflationary speed limit and groping to figure out what pace of job growth is sustainable.

"Is job growth at 130,000 just sufficient ... or is that pace above equilibrium?" Boston Fed President Cathy Minehan asked rhetorically.

STRUCTURAL SHIFTS IN SUPPLY