WASHINGTON- Federal Reserve Chair Jerome Powell used his first four years as the world’s top central banker to reshape US monetary policy around the idea that low inflation and low unemployment could coexist.
It was a move intended to spread the gains of economic growth more widely and keep a focus on jobs during the rebound from the pandemic.
But the assumptions on which it rested – a relatively frictionless global economy with a well-greased supply chain; a balanced US labor market with just over one open job for each unemployed person – have been shattered by events that appear to have put the Fed’s two goals of full employment and moderate inflation back in opposition.
Unemployment today at 3.6 percent is more akin to the 1950s and 1960s, with workers exercising leverage to negotiate higher wages and, given the pandemic, better working conditions. Inflation, however, is soaring at more than 8 percent annually, leaving Fed officials at a crossroads over how to tame it and facing the possibility that their “narrow path” back to the pre-pandemic world of low unemployment and low inflation may have all but closed.
Fed officials are expected to raise interest rates for a third time this year on Wednesday, with a three-quarters-percentage point increase now seen as the likely outcome, with the possibility of signals for more large hikes as long as inflation keeps far overshooting their 2 percent target.
In new projections, they will also provide their sense of what’s at risk, and what price the economy could pay through slowing growth and higher unemployment to get inflation back into line.
Arguably Powell’s approach did what was intended in the labor market. The employment rebound has been faster than many expected at the pandemic’s outset.
Distributionally, it has also helped, consistent with the Fed’s view of maximum employment as something “broad and inclusive.” Wages have risen fastest for lower-paid occupations; more Blacks and Hispanics are employed than before the pandemic, while white employment in May remained 1.6 million below February 2020’s peak.
Back in March, Fed officials saw inflation receding with no unemployment rate increase, but “we’re going to see some cracks” in that story in the new projections, predicted Nomura senior US economist Robert Dent. The median projected unemployment rate may just rise a couple of tenths of a percentage point in coming years, as Fed officials hang onto their view of an economy that may still revert to pre-pandemic form.
But “it is a tightrope…It would not be hard at all to see the economy tip into recession,” with joblessness rising to 5 percent or higher, he said. Some Fed officials have started opening the door to unemployment rates above 4 percent, the level policymakers roughly consider full employment.
That’s likely to fall hardest on Black and Hispanic workers, whose unemployment rates typically rise faster in downturns.
One unexpected outcome of the pandemic was a federal government response so strong that household incomes rose despite a recession. Some now argue the spending, in early 2021 in particular, left the economy with much more consumer demand than it can meet, adding to inflation.
