Larger rate cuts are now needed to stimulate labor income than in past decades

Larger rate cuts are now required to achieve the same stimulative effect on labor income and consumption as in past decades. The Federal Reserve Bank of New York has found that structural changes in the U.S. economy have weakened the transmission mechanism of monetary policy. While President Trump continues to demand immediate rate reductions, citing traditional economic stimulus logic, the underlying economy no longer responds as it once did.

The report, titled "Changes in Investment Structure and Weakening Influence of Monetary Policy," highlights that investments in intangible assets like software and intellectual property—less than 1% of GDP in the 1950s—now exceed 5.5% of GDP. These assets do not generate the same wage spillovers as physical capital. At the same time, a growing share of equipment investment is imported, limiting domestic income creation.

Automation has further eroded the link between investment and wages. The New York Fed calculates that domestic labor income generated per dollar spent on investment and durable goods has declined from 58 cents to 46 cents. With less of each investment dollar flowing into paychecks, the path from lower rates to higher consumption has narrowed.

As a result, the responsiveness of labor income to interest rate changes has dropped by 23% since the 2020s compared to the 1960s. Consumption responsiveness has fallen by 17%. The report warns that larger rate cuts are now needed to stimulate labor income than in past decades. Future recessions could leave central banks unable to lower rates further, limiting their ability to respond with monetary policy.