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The Fed May Finally Be Winning the War on Inflation. But at What Cost? [1]

['Michael Steinberger']

Date: 2023-01-10

Danny Blanchflower, an economist at Dartmouth College, was an author of a 2014 study that found that being unemployed was indeed worse for a person’s economic and emotional well-being than rising inflation. Like Sahm, he disagrees with the Fed’s rate increases (he thinks high inflation is, in fact, temporary), and is disappointed but not surprised that Kashkari, in his judgment, capitulated to the hawks. Blanchflower served for three years on the Bank of England’s Monetary Policy Committee and says the desire for consensus at central banks, especially in emergency situations, can make it very hard to hold dissenting views. Still, he wishes that Kashkari had stood firm. “His dovish message has been lost,” Blanchflower says. “Why did he give up?”

On Dec. 14, the Fed raised interest rates for the seventh time in 2022 and indicated that further increases were probable. In a news conference that day, Powell, the Fed chair, said he didn’t think anyone knew whether a recession was inevitable but acknowledged that the odds of achieving a so-called soft landing — in which inflation is brought under control by slowing economic growth without causing a recession — were diminishing. He seemed to suggest that hard times were coming. “I wish there were a completely painless way to restore price stability,” Powell said. “There isn’t.” It was a sobering message not just for the public but perhaps also for President Biden, whose political fortunes could hinge on what the Fed does from here. (Powell declined to comment for this article.)

The encouraging news is that inflation is easing. The Consumer Price Index, or C.P.I., which is the government’s main inflation gauge, rose 7.1 percent, down from a peak increase of 9.1 percent recorded in June. Since then, the average price of gas has fallen by $1.19 per gallon. It seems most of the arrows are now pointing in the right direction. An exception, at least from the Fed’s perspective, is the labor market. The Fed is worried about wage growth as a source of inflation. With unemployment so low, companies are having to pay more to keep the workers they have and to hire new ones. Wages are currently rising at around 5 percent year over year, and unless that slows, the Fed will struggle to get inflation back to around 2 percent — and the danger is that if it doesn’t slow, businesses will raise prices to cover their added labor costs, which could spark a dreaded phenomenon known as the wage-price spiral. Odd as it might seem to regard wage increases as a problem, Fed officials note that inflation is eroding those gains.

It’s possible that the labor market has undergone a structural change as a result of the pandemic. At least 1.1 million Americans have died from Covid-19, which has effectively shrunk the pool of available workers. Long Covid has undoubtedly sidelined many Americans, and the pandemic also led a lot of people to take early retirement. The upshot is that there are not enough workers to fill all the available jobs, a situation made worse by the prepandemic decline in legal immigration. According to the Bureau of Labor Statistics, there are currently 1.7 job vacancies for every one job seeker. When I spoke to Kashkari in early December, he noted that, even after all the Fed’s rate increases, the labor market was still incredibly tight. “The No. 1 issue I hear from employers in our region is that they can’t find workers,” he said. “There’s no evidence when I talk to them of any softening of labor demand.”

The Fed hopes that vacancies will decline as businesses resign themselves to leaving jobs unfilled and that this might be enough to cool wage growth without a sizable uptick in unemployment. In its most recent forecast, however, released last month, the Fed projected that unemployment would rise to 4.6 percent from 3.7 percent this year, which equates to the loss of around 1.5 million jobs. There is skepticism among economists that the central bank can bring inflation down to its target rate without a big jump in joblessness. “Getting all the way to 2 percent could be very hard,” says Jason Furman, the economist at Harvard. “I think it could require a large increase in unemployment if the Fed really needs the inflation rate to get back to 2 percent.”

The prospect of mass layoffs and a recession has prompted renewed discussion about whether the Fed should even be aiming for 2 percent inflation, which has been the official target since 2012 (and was the unstated goal for many years before that). Some economists argue that 2 percent is too low because it constrains the Fed’s ability to pull the economy out of downturns, and they fear that the cost of driving inflation back to that level could be punishing. “In the months ahead,” the New York Times Opinion columnist Paul Krugman recently wrote, “we may well face a choice between imposing a recession to get inflation back down to a largely arbitrary target, which we wouldn’t have chosen 20 years ago if we’d known then what we know now, and declaring victory with inflation fairly low but not quite that low.”

Fed officials insist that they have no intention for now of backing away from 2 percent. At his news conference last month, Powell was unequivocal: “We’re not going to consider that under any circumstances.” When I spoke recently with the former Fed chair Ben Bernanke, he told me that it would be a mistake for the central bank to abandon its own target while battling the highest inflation that the country has experienced in decades. “Whatever the merits of the case for changing the inflation target in the long run, it can’t be done now because of the damage it would do to the Fed’s credibility,” Bernanke said. “You can’t move the goal posts when you are behind in the game.”

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[1] Url: https://www.nytimes.com/2023/01/10/magazine/inflation-federal-reserve.html

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