Assessing Federal Reserve Models: Immigration Policy and Inflationary Pressures in a Post-2024 Landscape

The interplay between U.S. immigration policy and inflationary pressures has emerged as a critical focal point for investors and policymakers alike. As the Federal Reserve navigates an evolving economic landscape, the accuracy of its models in predicting the macroeconomic impacts of immigration policy changes remains under scrutiny. Recent data and academic analyses reveal a nuanced relationship between immigration dynamics, labor market tightness, and inflation, challenging the assumptions embedded in traditional Federal Reserve frameworks.

The Fed's Models: A Structural Blind Spot?

The Federal Reserve's structural vector autoregression (VAR) models, such as those developed by the Dallas Fed, suggest that immigration policy changes have minimal direct effects on inflation but significant implications for GDP growthDeclining immigration weighs on GDP growth, with little impact on inflation^[2]. For instance, an unexpected increase in unauthorized immigration is estimated to boost output growth for two years but leave inflation largely unchangedDeclining immigration weighs on GDP growth, with little impact on inflation^[2]. However, real-world data post-2024 paints a different picture. Stricter immigration enforcement measures—ranging from reduced visa issuance to mass deportations—have led to a 0.8% decline in the foreign-born labor force between mid-2024 and September 2025A Primer on Recent Immigration Inflows - Federal Reserve Bank of Chicago^[3]. This reduction, equivalent to a 2.1 million-person labor force contractionA Primer on Recent Immigration Inflows - Federal Reserve Bank of Chicago^[3], has tightened labor markets in sectors reliant on immigrant labor, such as agriculture and construction, driving wage growth and, consequently, inflationary pressuresImmigration and the macroeconomy after 2024^[1].

The Federal Reserve's 2025 Summary of Economic Projections, which forecasts core PCE inflation at 3.1% for 2025 with a gradual return to 2% by 2028FOMC Summary of Economic Projections, September 2025^[5], appears to understate these indirect effects. While the models account for GDP growth impacts, they may overlook the second-order consequences of labor supply shocks on wage dynamics and pricing power. For example, the “break-even” level of monthly job creation required to stabilize unemployment has doubled from 80,000 to 160,000 since 2021, reflecting immigration-driven labor force expansionA Primer on Recent Immigration Inflows - Federal Reserve Bank of Chicago^[3]. This suggests that the Fed's traditional metrics for assessing labor market equilibrium may no longer align with reality, potentially leading to misjudged inflation trajectories.

Immigration Policy: A Double-Edged Sword for Inflation

The inflationary impact of immigration policy hinges on its dual role as both a supply-side and demand-side force. On the supply side, reduced immigration has exacerbated labor shortages, pushing wages higher in industries with inelastic labor supply. A structural VAR model estimates that declining unauthorized immigration could reduce GDP growth by 0.75–1 percentage points in 2025 compared to Congressional Budget Office projectionsDeclining immigration weighs on GDP growth, with little impact on inflation^[2]. This contractionary effect on output, however, is offset by upward pressure on wages, which risks spilling over into consumer prices.

Conversely, immigration historically acted as a deflationary force by expanding the labor supply during periods of high job vacancies. Between 2021 and mid-2024, surging unauthorized immigration helped absorb labor demand, mitigating inflationary pressuresHow U.S. immigration changes could impact inflation and the Fed^[4]. The reversal of this trend—marked by a 45,000 monthly decline in migrant labor supply between June and December 2024Immigration and the macroeconomy after 2024^[1]—has reintroduced inflationary risks, particularly in sectors facing acute labor shortages.

Demand-side effects further complicate the picture. Immigrants contribute to consumption growth in housing, groceries, and transportation, temporarily outpacing capital investment and creating inflationary imbalancesDeclining immigration weighs on GDP growth, with little impact on inflation^[2]. This dynamic is amplified by the time lag between policy changes and their economic effects, leaving the Fed with limited real-time data to adjust its models accordingly.

Policy Scenarios and Investment Implications

The potential divergence in immigration policy under different administrations underscores the uncertainty facing investors. Under a Kamala Harris administration, projected net immigration of 3.7 million in 2025 could bolster GDP growth and temper inflation through increased labor supply and consumer demandImmigration and the macroeconomy after 2024^[1]. Conversely, Trump's proposed mass deportation policies—projected to result in net outmigration of -740,000 by 2026—could shrink GDP by $130 billion in 2025 aloneImmigration and the macroeconomy after 2024^[1], exacerbating inflation through wage-driven cost-push pressures.

For investors, these scenarios highlight the importance of hedging against labor market volatility and inflationary surprises. Sectors such as construction, agriculture, and healthcare—highly dependent on immigrant labor—are particularly vulnerable to policy-driven supply shocks. Conversely, asset classes like Treasury Inflation-Protected Securities (TIPS) and real estate investment trusts (REITs) may offer inflationary buffers in a prolonged high-inflation environment.

Conclusion: A Call for Model Modernization

The Federal Reserve's current models, while robust in capturing GDP impacts, may lack granularity in forecasting the inflationary ripple effects of immigration policy. As immigration continues to reshape labor markets and economic growth, the Fed's 2025 review of its monetary policy framework must incorporate dynamic labor force participation metrics and sector-specific inflation driversA Primer on Recent Immigration Inflows - Federal Reserve Bank of Chicago^[3]. For now, investors should remain vigilant, recognizing that immigration policy is not merely a political issue but a pivotal determinant of inflationary trajectories and asset valuations.