The overriding message of the Federal Reserve’s communications on Wednesday was simple: its leaders believe that significant economic pain is necessary to bring down inflation, and they are prepared to impose it.
Why is this important: The Fed is now forecasting a significant rise in unemployment over the next year as it pushes interest rates to their highest levels since 2007 – implying that it will not just tolerate a recession or near-recession, but will consider it as proof of success.
- It’s a contrast to just three months ago, when policymakers clung to a more bullish story in which inflation resolves itself with just a bumpy correction for the economy.
- “We need to put inflation behind us,” Chairman Jerome Powell said during his press conference on Wednesday. “I wish there was a painless way to do this. There isn’t.”
The big picture: What matters most for the economic and political outlook is who feel this pain, and How? ‘Or’ What. Already, some on the left are attacking the Fed for throwing workers under the bus in its campaign to fight inflation.
- Perhaps most importantly, Sen. Elizabeth Warren (D-Mass.) tweeted yesterday that she “warned that Chairman Powell’s Fed would put millions of Americans out of work – and I fear he is already on track to do so.”
- If yesterday’s projections turn out to be correct – meaning an unemployment rate of 4.4% at the end of next year, down from a low of 3.5% in July – that would imply 1.5 million ‘Additional Unemployed Americans.
- Hypothetically, unemployment could rise that much due to a simple downturn in the economy. But in practice, historical examples of what is happening are rare. Unemployment only increases in recessions.
There is no doubt that in this scenario, moderately higher unemployment is, in fact, a goal of the Fed, with all the moral and political consequences that entails. But it goes too far to say that workers bear the brunt of the war on inflation.
- The Fed’s monetary tightening has first-order effects on financial markets, as evidenced by the 21% collapse of the S&P 500 this year.
- Indeed, if you think, like many people, that the era of zero interest rates and quantitative easing made the rich richer and increased inequality, then the era of rate hikes and tightening quantitative should have the opposite effect.
There are many channels whereby Fed tightening can help bring down demand and inflation without people losing their jobs. For instance:
- A wealthy investor decides he can’t afford a vacation home because of stock market losses.
- Or a company accepts lower profit margins because it thinks it cannot raise prices in times of crisis.
Reality check: But just because these channels exist doesn’t mean the job losses won’t be the biggest in how people experience the economy.
The bottom line: The 1.5 million people who could lose their jobs in the Fed’s scenario will suffer much more than the tens of millions who experience a moderately lower balance in their investment portfolio.