Federal Reserve Chair Jerome Powell has warned that getting inflation under control will involve “some pain to households and businesses.” What kind of pain is he talking about?
So far, the pain has been plunging stock values and higher borrowing costs for homes, cars, credit-card purchases and business investments. But the toll could also include a surge in unemployment, and all the strains that go along with it—which typically harms lower-income workers most of all.
Powell won’t explicitly say the Fed is trying to put people out of work, but that’s one implied goal of its newly aggressive rate-hiking blitz. The Fed has raised short-term interest rates by 3 percentage points so far this year, and economists think it will push them up another point or two during coming months. Higher borrowing costs typically depress spending, with softer demand bringing inflation down.
The Fed thinks a flurry of rate hikes will tame inflation without choking off growth so much that it causes a recession. That would be a “soft landing.” But the Fed could be wrong. “This soft landing doesn’t add up to us,” investing giant BlackRock advised in a Sept. 26 market analysis. “We think quashing inflation that quickly … would take a recession.”
BlackRock thinks GDP would have to contract by about 2 percentage points to cut inflation as quickly as the Fed is aiming to do. That would put about 3 million Americans out of work, in BlackRock’s estimate. The unemployment rate would rise from 3.7% now to around 5.5%. That would be a moderate downturn, as recessions go. But should the Fed really throw people out of work in order to lower inflation?
The Fed has a so-called dual mandate: to maximize employment and keep prices stable. The Fed defines stable prices as an inflation rate of around 2%. With inflation currently at 8.3%, the Fed clearly has some work to do. Employment, on the other hand, is so strong that many companies still can’t find enough workers. Nobody at the Fed will come out and say it, but on its current path, the Fed is sending the message that getting prices down is more important than protecting jobs.
The Fed is hiking rates at the fastest pace since the early 1980s, because inflation is at the highest levels since then. In the spring of 1980, inflation hit 14.6%, the highest level in modern history. The Fed, under chairman Paul Volcker, raised rates by about 10 percentage points during a 12-month period from 1980 to 1981. A recession followed, with the economy losing 2.8 million jobs. Since the economy was smaller then, those lost jobs pushed the unemployment rate to 10.8%, far higher than anybody thinks the jobless rate will go if today’s Fed triggers another recession.
But that doesn’t mean a Fed-induced recession would be fine and dandy. Wharton professor Jeremy Siegel has blasted the Fed for worrying too much about inflation and not enough about how a recession could hurt ordinary workers. Tesla CEO Elon Musk, who thinks a recession is coming, tweeted that “Siegel is obviously correct.” Democratic Sen. Elizabeth Warren of Massachusetts has warned that the Fed will “slow demand by getting a lot of people fired and making families poorer.”
Powell, for his part, argues that the risk of a recession is worth tolerating because persistent inflation would cause “greater pain later on.” He’s not wrong about the nasty effects of prolonged inflation, which go way beyond the high gasoline prices that unnerved drivers during the summer. The worst may be the decline in living standards that comes as wages fail to keep up with rising prices, especially the cost of essentials. When the Fed began hiking rates in 1980, real wages, adjusted for inflation, were falling 6% year-over-year.
That’s a problem now, too. Average wages are growing 4.4%, but with inflation at 8.3%, real wages are declining by 3.9%. That’s unsustainable. What the Fed should do about that, however, gets to the whole question of what is causing inflation in the first place.
'We're never going to say there are too many people working'
BlackRock argues that two main factors are driving prices up: a worker shortage, and a surge in demand for goods during the COVID pandemic, which still hasn’t abated. Other factors, such as the unprecedented fiscal and monetary stimulus of the last two years, are probably lesser factors. The problem, BlackRock says, is that the Fed can’t address either of those two core problems through rate hikes, or any other tool at its disposal. That leaves a recession as the de facto fix for inflation, since a recession, by definition, destroys jobs, lowers incomes and reduces demand for goods — bringing prices down.
Unemployment, obviously, can be a pernicious problem for those experiencing it. In addition to lost income, joblessness disconnects workers from the labor market, which can make it harder to find work even when the recession is over. Some jobs disappear completely during a recession, as employers take advantage of layoffs to replace workers with technology. Unemployment insurance and other types of aid help cushion the blow, but the United States has a weak safety net for jobless workers, compared with other advanced economies.
Inflation and unemployment both hit lower-income workers harder than those who are better off. Lower-income workers simply lack the cushion to absorb higher prices or comfortably ride out a bout of unemployment. Inflation hurts little-by-little over a long period of time. Unemployment hurts a lot right away, and for as long as it lasts. Choosing one form of pain over the other is a Hobson’s choice.
Even Powell has begun to hint it may take a recession, and millions of lost jobs, to lower inflation to acceptable levels. The Fed’s own prediction is for the unemployment rate rising to 4.4% during the next 12 months, which would equate with about 1.3 million lost jobs.
“We think we need to have softer labor market conditions,” Powell said, euphemistically, after the Fed’s last meeting, on Sept. 22. “We’re never going to say there are too many people working, but … people are really suffering from inflation.” And soon, from unemployment.