Why is the Fed raising unemployment?

Federal Reserve Chairman Jerome Powell said Wednesday that it will be nearly impossible for the central bank to beat inflation without hundreds of thousands of Americans losing their jobs.

Fed officials expect the unemployment rate to rise to 4.4 percent next August from 3.7 percent as they raise borrowing costs and slow the economy, according to forecasts released Wednesday.

Experts say that such a rise in the unemployment rate in one year would likely push more than 1 million workers out of their current jobs and leave millions more unable to find better jobs or higher wages.

“We certainly haven’t given up on the idea that we can get a relatively modest increase in unemployment,” Powell said Wednesday after the Fed’s next massive rate hike.

“Nevertheless, we must complete this task,” he said.

Simply put, the Fed knows that past and future interest rate hikes will lead to higher unemployment, so it won’t stop fighting inflation.

But rising unemployment isn’t just a side effect of the Fed’s plans: it’s the goal.

Powell and many other economists believe that the US labor market is too strong to allow inflation to fall. The combination of very low unemployment and record high jobs has fueled rapid wage growth, they argue, forcing businesses to raise prices to cover higher labor costs.

Powell has argued for months that the Fed must bring the labor market to “balance” in order for inflation to return to normal levels. But that means putting people out of work and giving them fewer opportunities to find work after two years of rapid inflation.

“It will be very painful for the families who will be hit with a double blow. Not only do prices continue to rise, they may also lose their jobs at this very high rate of inflation,” said Derek Tang, co-founder and economist at research firm Monetary Policy Analytics.

The Fed is required by federal law to keep both unemployment and inflation as low as possible. To do this, the bank lowers interest rates to stimulate the economy when unemployment is high and raises rates to slow the economy when inflation starts to rise.

After cutting rates to near zero at the start of the pandemic, the Fed waited too long to start raising interest rates as the economy recovered and inflation picked up in 2021. hill

“The question is, are we going to hit the brakes or not?” Preston Mui, an economist at the research nonprofit Employ America, wrote in an email Friday.

“Pulling the economy into recession is likely to ease inflation, but it will do so at a very high cost.” These unemployed people will not only be out of work for a year; these workers will likely see depressed employment and incomes within a decade.

But Powell and supporters of the Fed’s rapid rate hikes say it’s a necessary trade-off to avoid a worse downturn.

The Fed failed to suppress inflation for decades as it soared in the 1960s and 70s, leading to an ever-increasing spiral of prices and wages. Rising inflation hit the economy hard until the Fed, under former chairman Paul Volcker, deliberately triggered a recession with a shock rate hike.

Powell has argued for months that a temporary recession that helps keep inflation down for good is better for the U.S. than letting inflation spiral out of control and lead to a deeper, more painful recession.

“If we’re going to usher in another era of very strong labor markets, we have to put inflation behind us. I wish there was a painless way to do this. No,” Powell said Wednesday.

Experts say the pain is coming first, as is the overall decline in wage growth, with incomes likely to fall even further than prices. At that time, companies will likely be forced to scale back open jobs before some face the need to cut hours or employees due to declining sales in a weak economy.

“As interest rates rise, it becomes more expensive to do business. So I think everybody’s worried they’re going to slow down hiring,” said Jane Oates, a former Labor Department official and president of WorkingNation, a research and advocacy nonprofit.

Oates added that the slowdown will also raise questions about the strength of hiring during the holiday season, which is often a re-entry point for workers who drop out of the labor market. There were still about 1.6 million fewer Americans in the labor market in August than there were in February 2020, and a slower labor market may provide few opportunities for them.

Critics of the Fed’s approach also believe the central bank is overestimating how much damage it would have to do to the labor market to bring down inflation.

Mui of Employ America argued that the Fed’s focus on the ratio of jobs to unemployed workers is misguided because the jobs data “doesn’t reflect how the job search is actually happening.” He added that relying on the Fed to suppress demand would do little to remove the supply constraints that drive up prices.

“The bulk of the current inflation we’re seeing is driven by supply issues, particularly in industries, caused by the pandemic,” he said.

“The Fed’s projections show that it is poised to absorb more than a million jobless workers over the next few years. I think it’s a very expensive way to go, given the weakness of the evidence that it’s necessary.

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