If the U.S. economy wasn’t already suffering enough, the Federal Reserve has a message for Americans: It’s about to get significantly worse.
Fed Chair Jerome Powell made this very plain last week when the central bank forecast that its benchmark rate would reach 4.4% by the end of the year, regardless of whether or not this would precipitate a recession.
In his economic forecast released on September 21, Powell predicted that labor market conditions will likely soften. We shall persist until we are certain that the task has been completed.
In simple terms, it indicates unemployment. The Fed predicts that the unemployment rate would rise to 4.4% next year, from 3.7% currently, which would imply an extra 1.2 million job losses.
Powell stated, “I wish there was a painless method to accomplish this.” There is none.
Hurt so good?
This is the reasoning behind why increasing unemployment could reduce inflation. With an additional million or two unemployed, the newly unemployed and their families would drastically reduce spending, while wage growth would stagnate for the majority of those who are still employed. According to the hypothesis, when businesses believe that their labor costs are unlikely to rise, they will cease raising prices. In turn, this slows the growth of prices.
However, other economists dispute whether stifling the employment market is required to rein in inflation.
“Clearly, the Fed wants the labor market to contract significantly. What we do not understand is why “In a report, Ian Shepherdson, chief economist of Pantheon Macroeconomics, stated: As supply chains adjust, he forecasts that inflation will “plunge” next year.
The Federal Reserve is concerned about a so-called wage-price spiral, in which workers seek higher wages to keep up with inflation and employers pass along these increased labor costs to consumers. However, analysts argue that wages are the primary cause of the current red-hot inflation. In the past year, wages have increased by an average of 5.5%, but this growth has been dwarfed by price rises. Former Fed economist Claudia Sahm observed in a tweet that at least half of today’s inflation stems from supply-chain difficulties.
A substantial amount of US inflation (chart) and a very substantial portion of German inflation are attributable to supply side causes. With sufficient demand destruction, central banks may currently reduce inflation, albeit momentarily and at tremendous cost. Why bother? pic.twitter.com/pbNEjKf93V
— Claudia Sahm (@Claudia Sahm) September 22, 2022
Sahm observed that today’s low-paid workers have benefited the most from wage increases and suffered the most from inflation, which is driven by increasing spending by wealthy households and not by those earning less.
Increasing rates and declining employment
While the precise relationship between wages and inflation is still a matter of controversy, economists are much clearer on how an increase in interest rates leads to unemployment.
Josh Bivens, director of research at the Economic Policy Institute, remarked, “As interest rates increase, the price of all debt-financed consumer goods — including vehicles and washing machines — increases.”
This will eventually result in layoffs for the workers that produce these automobiles and washers. Other interest-rate-sensitive sectors of the economy, such as construction, home sales, and mortgage refinancing, slow down as well, impacting employment in this area.
In addition, fewer people are traveling, causing hotels to cut staff to compensate for lower occupancy levels. When financing prices are high, businesses intending to expand, such as a coffee shop chain launching a new location, are hesitant to do so. And when individuals spend less on travel, dining out, and entertainment, hoteliers and restaurateurs will have fewer customers to serve and will subsequently reduce their workforce.
“In the service sector, labor is the largest component of your cost structure, so if you’re wanting to cut costs, you’ll start there,” said Peter Boockvar, chief investment officer at Bleakley Financial Group.
While Boockvar believes that a rate hike is necessary, he finds the Fed’s actions to be harsh. “My only issue is with the Fed’s speed and scope,” he remarked. I’m concerned that the economy and markets won’t be able to withstand their speed and strength.
Fears of an economic downturn are stoked by the possibility of a Fed interest rate hike.
According to projections made by Oxford Economics, the Fed’s current rate hikes have paved the way for the loss of almost 800,000 jobs.
Nancy Vanden Houten, Oxford’s chief U.S. economist, stated, “When we look at 2023, we expect essentially no net hiring in the first quarter and employment losses of around 800,000 or 900,000 in the second and third quarters combined.”
Others, including the Bank of America, forecast an even more difficult landing, with the jobless rate reaching a top of 5.6% next year. This would result in an additional 3,2 million unemployed individuals above current levels.
Some policymakers and economists have criticized the Fed’s aggressive rate hike plans, with Senator Elizabeth Warren stating that they “would cause millions of Americans to lose their jobs” and Sahm describing them as “inexcusable, verging on hazardous.”
Chair of the Federal Reserve, Jerome Powell, has just announced another drastic increase in interest rates while predicting rising unemployment.
I’ve been saying that Chairman Powell’s Fed will put millions of Americans out of work, and I’m afraid he’s well on his way.
— Elizabeth Warren (@SenWarren) September 21, 2022
Powell promised suffering, and many are questioning how much suffering is required.
“In the event of a recession, inflation will fall considerably more quickly. However, the expense of doing so will be far higher “said Bivens added.
With the S&P 500 down 22% this year — “bear market” territory — the threat of further layoffs coincides with a loss in the wealth of many Americans due to the falling stock market. According to Oxford Economics, between April and June, the overall net worth of households fell by more than $6 trillion, or more than half of the $11.1 trillion in value that evaporated across five quarters during the 2007-2009 financial crisis.
The concern, according to Bivens, is that the Fed has caused a runaway train. Once unemployment begins to rise dramatically, it is difficult to stop it. Instead of halting at the 4.4% rate forecast by Fed experts, the unemployment rate could continue to rise.
Bivens stated, “The notion that the Fed can simply turn up the inflation dial while leaving everything else unchanged is a misconception.”
Bivens added that, contrary to the Fed’s stated goal of a smooth landing for the economy, “we are now pointing the plane straight at the ground and pressing the accelerator.”