Analysis: Inflation vs. job gap: a compromise the Fed still hopes to get around
WASHINGTON, Aug. 25 (Reuters) – The Federal Reserve’s year-old pledge to take U.S. employment to new heights came at a heartbreaking time last August, with 12 million jobs still missing due to the pandemic, with inflation hitting half of the central bank’s target, and no clear endgame for the worst health crisis in a century.
Then came three vaccines, a steady recovery in jobs, billions of additional dollars in fiscal stimulus, the fastest economic growth in 40 years – and soaring prices.
A steady shift in the Fed’s rhetoric since inflation surged in the spring has now sparked a debate on the depth of the Fed’s new commitment to jobs and how long it will tolerate high inflation in the spring. waiting for a “broad and inclusive” rebound in employment.
No decision has been made. The Fed is actively discussing when it will cut its emergency bond purchases by $ 120 billion per month, and Fed Chairman Jerome Powell could discuss that on Friday in a virtual iteration of its research conference annual at Jackson Hole. The bigger call to raise interest rates close to zero is, in all likelihood, far from it.
But with each successive report showing inflation above the Fed’s 2% target, the tone has changed. Fed officials now readily admit that inflation may be more persistent than they thought. Additionally, some are lowering expectations of a full rebound to pre-pandemic employment or labor market participation levels.
The debate will not be resolved anytime soon. But the suddenly bilateral nature of the discussion has, for some, called into question the value of the Fed’s new approach.
“I think they’ve lost their temper,” said Adam Posen, chairman of the Peterson Institute for International Economics and former member of the Bank of England’s Monetary Policy Committee. In recent comments, “they have failed to strengthen their commitment to broad and inclusive gains” in the labor market.
Richard Clarida, influential Fed chairman, would disagree. In a recent presentation to the Peterson Institute, he said his inflation outlook was above 2% for three consecutive years, with unemployment so low by the end of 2022 that the gains would be widely felt and that jobs would return to pre-pandemic levels, and a rate hike in 2023 “fully in line” with the Fed’s new approach.
INFLATION VS EMPLOYMENT
Arguably the latest inflation readings, the latest being almost double the 2% target level, would have been more aggressively faced by previous Fed.
Some believe that a stricter approach may be needed now.
“It’s getting a little old to say this is a transitory price hike,” said Vincent Reinhart, chief economist at Mellon, pointing to surveys showing companies ready and able to weather price hikes. price. “If companies say they care about the prices paid and they have pricing power, then… we don’t have price stability. The wheels are greased so the costs are passed on.”
Under the new framework, however, the Fed has pledged not to nip job growth in the bud and, to make sure inflation hits the 2% target on average, it will allow it to exceed. this level “moderately … for a while”. “
However, when the new strategy was rolled out, it had an even deeper kind of commitment. Policymakers have long seen the tension between unemployment and inflation. If inflation gets too high, the Fed can bring it under control through rate hikes, but at the cost of higher unemployment. When inflation is low or unemployment is high, it can lower rates and trade more jobs for higher prices.
More than 10 years of economic expansion after the 2007-2009 recession, this relationship has not held up. As unemployment fell, inflation remained subdued, and Fed officials concluded they could exploit that and take more inflation risks to create the kind of ‘hot’ economy and robust labor market. which helps the less wealthy.
Fairness is not a goal addressed in the Fed’s congressional mandate, but officials have paid more attention to the issue as the economic costs of inequality have become more appreciated.
The dilemma arose when the pandemic rekindled what the Fed thought it had missed: the conflict between inflation and jobs.
At the heart of the framework debate in 2019, the Fed saw plenty of jobs and low inflation; now inflation is high, but with 6 million less working people than before the pandemic.
This forced an earlier-than-expected calculation on the issues left hanging in the new strategy.
What does “moderately” mean when it comes to exceeding inflation? How well can the economy recreate the pre-pandemic conditions where, for example, unemployment reached record highs for African Americans and the share of adults employed or looking for work was steadily increasing?
The “labor market participation rate” reached 63.4% in January 2020. It is now 61.7%. Unemployment among blacks reached a record high of 5.2% in August 2019, and even then it was 1.8 percentage points higher than that of whites. In July, it was 8.2%, compared to 4.8% for whites.
AN “AMBITIOUS” OBJECTIVE
With inflation gnawing away, some Fed officials have started to wonder what to expect from the job recovery.
Clarida, rather than seeing a full rebound in the labor force participation rate, says it may revert to an unspecified “demographic trend” driven down by the aging population.
Where Powell spoke about the plight of displaced workers, he also notes the number of additional people, perhaps 2 million or more, who have retired during the pandemic – thus lengthening the time it takes to return to employment levels. before the pandemic, and increasing the likelihood that the Fed will raise interest rates before that happens.
It all depends on inflation. If it turns out to be the product of global supply shocks and reopening, and recedes on its own, the potential trade-off with the labor market eases.
Otherwise, the Fed’s priorities will be tested in a way that was not envisioned when the new strategy was approved.
“They have set themselves a very ambitious target. This is the first year … We don’t know if it’s a success for at least a few years,” said Edward Al-Hussainy, senior rate and currency analyst. for Columbia Threadneedle Investments. “The first priority remains the recovery of the labor market … People are starting to lose sight of this.”
Reporting by Howard Schneider; Editing by Dan Burns and Andrea Ricci
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