But so far, the reality has been anything but, as interest rates have soared, inflation has fallen from a peak of 9.1% in June 2022 to 3.7%. But the unemployment rate remains low at 3.8%, little changed since March 2022, when the Fed began its 11th consecutive interest rate hike at the fastest pace in decades.
If these trends continue, central banks could achieve a rare and difficult “soft landing,” or controlling inflation without triggering a deep recession. Such an outcome would be very different from the last time inflation spiked in the 1970s and early 1980s. Then-Fed Chairman Paul Volcker attacked inflation by raising the central bank’s key short-term interest rate above 19%. result? The unemployment rate rose to 10.8%, the highest level since World War II at the time.
A year ago, Chairman Jerome Powell said in a high-profile speech that raising interest rates would cause “some pain” in the form of higher unemployment, and warned that the Fed was prepared to be aggressive as well. Chairman Powell pointedly said the Fed would “keep it at it,” a play on the title of Volcker’s autobiography, “Keeping At It.”
As time went on and the job market showed remarkable resilience, Mr. Powell adopted a softer tone. At a press conference last week, he suggested a soft landing was “a possibility” even if it was not guaranteed.
“That’s what we’ve seen in practice,” he said. “For now, we will move forward without an increase in unemployment.”
How could the Fed’s rate hikes significantly slow inflation without causing dire consequences? And even though the Fed intends to keep borrowing rates at their peak until 2024? Will the job market and economy maintain its durability?
Here’s a look at the reasons for the economy’s unexpected resilience and whether it’s likely to last.
Replenishing supplies is helping to curb inflation
The idea that unemployment needs to rise significantly to overcome high inflation is based on long-standing economic models that may prove inappropriate for the post-pandemic situation.
Former Federal Reserve economist Claudia Sahm said people who think surging unemployment is the price they have to pay to overcome inflation argue that the price hikes of the past two-and-a-half years were primarily caused by overheating demand. He indicated that he believed it. Homebound consumers ramped up spending on patio furniture, stationary bikes and home office equipment as stimulus checks hit their bank accounts.
But to curb demand-driven inflation, the Fed would have had to rein in spending, causing sales to plummet and forcing businesses to cut jobs. But even as Americans overall continue to spend freely on shopping, travel, and entertainment, inflation has cooled.
Alan Detmeister, a former Federal Reserve economist now at UBS, said: “The fact that the economy is recovering without rising unemployment and without a significant slowdown in consumption suggests that the actual cause was elsewhere.” It suggests that.”
Mr. Detmeister and other economists increasingly believe that supply disruptions caused by the pandemic and Russia’s invasion of Ukraine played the biggest role in accelerating inflation. Even as spending on goods surged, spending on services fell, with overall demand broadly in line with pre-pandemic trends.
Detmeister said this inflation episode could end up looking more like the one that occurred after World War II than the one of the late 1970s and early 1980s. After World War II, manufacturing output slowed as factories retooled from wartime production. At the same time, many returning military personnel moved to the suburbs, and demand for housing, appliances, and furniture soared. Still, inflation eased once production resumed.
Mike Konczal, director of the Roosevelt Institute think tank, found in a recent study that the price of nearly three-quarters of goods and services falls as quantity increases. This suggested to him that the increase in supply was the main reason for the decline in inflation. (This figure excludes volatile food and gas prices to give you an idea of underlying trends.)
It is unclear how long this trend will continue to slow inflation. Boston Fed President Susan Collins said Friday that the recovery in supply has indeed eased commodity inflation. But the cost of most services “has not yet shown the sustained improvement” needed to bring inflation down to the Fed’s 2% goal, he said.
Konczal remains optimistic. Inflation has slowed in many service sectors, including restaurants, laundry services and veterinary care, even though demand hasn’t fallen as much.
“The disinflation we are seeing is therefore widespread and likely to continue,” he said in a research paper.
The job market has changed
There was another supply improvement in the labor market. It’s the supply of labor. About 3.4 million people have started looking for work since the Fed started raising interest rates last year. One big driver is a rebound in immigration following the easing of pandemic-era restrictions.
And even more job seekers continue to pursue side hustles. The proportion of adults in their prime working years (25 to 54) who are employed or looking for work has reached its highest point in 20 years.
At the same time, businesses seem to need fewer workers. But instead of cutting jobs, they want fewer new hires. The number of open jobs fell from more than 12 million last year to 8.8 million in July, but remains well above pre-pandemic levels. And fewer people are quitting their jobs in search of higher wages.
Chairman Powell said last week that fewer job openings and more workers mean the labor market is more balanced. This eased the pressure on companies to raise wages to find and keep workers. Still, with inflation easing, hourly wages are now growing faster than prices.
Even among companies that are concerned about the future of the economy, many are more reluctant than before to cut staff. Jay Starkman, CEO of Engage PEO, which provides human resources services to small and medium-sized businesses, said many employers were overwhelmed by the rapid layoffs and subsequent rapid rehiring that occurred during and after the 2020 pandemic recession. He said it appeared to be “dangling.”
“Employers today are saying, ‘Well, my business is down a little bit.’ For now, we can put up with these employees. Find and train great employees again. I really don’t want to do that work.”
Consumers and businesses continue to operate
Another reason why high interest rates haven’t caused unemployment to skyrocket is that many households and businesses have been better protected from rate hikes than before.
Americans overall saved a significant portion of the economic stimulus checks and expanded unemployment benefits they received during the pandemic. These savings have continued to boost consumer spending this year.
Fed officials are watching how long these savings will continue to support spending. Americans are racking up credit card debt, a sign that they are running out of savings. Bank of America said credit card balances for high- and moderate-income customers remain below pre-pandemic levels, but have increased significantly for lower-income customers.
Businesses, especially large ones, also took advantage of low interest rates in 2020 and 2021 to refinance debt and reduce payments. As a result, interest rate hikes have not necessarily increased borrowing costs. Over time, much of that borrowing will have to be refinanced at higher interest rates, according to a report from the Fed’s Boston branch. That could hurt profit growth and cause companies to lay off workers.
So far, some companies are benefiting from government subsidies from legislation pushed by the Biden administration, including measures to boost investment in infrastructure, renewable energy and semiconductor manufacturing. Spending on new factories surged in response.
“We’ve seen a recovery on the supply side, and part of the driver of that is public investment,” said Daleep Singh, chief global economist at PGIM Fixed Income and previously the administration’s top economic official. Told.
Fed policymakers revised their economic outlook last week, saying that core inflation, which excludes volatile food and energy, will be 2.6% by the end of next year, down from the current 4.2%, according to the Fed’s recommended metrics. It was done. At the same time, he expects the unemployment rate to rise to just 4.1%, below his June forecast of 4.5% in 2024.
“If we actually get that kind of outcome without a recession, that’s a very good outcome given the scope of the shock,” said William English, a former Fed official and current professor at Yale School of Management. .
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