Sophia Cho and John C. Williams

Over the past quarter century, the U.S. economy has experienced significant declines in both the labor share of income and the natural rate of interest, referred to as R*. Existing research has largely analyzed these two developments in isolation. In this post, we provide a simple model that captures the joint evolution of the labor share and R*, which we call the R*–labor share nexus. Our key finding is that structural changes affecting R* also influence the evolution of the labor share, and thereby wages and prices. This highlights a potentially important channel, absent from many macroeconomic models, through which the factors that determine R* also affect the labor share and, in turn, broader macroeconomic developments, with implications for monetary policy.