The US Federal Reserve Building in Washington

Fed’s “inclusive” jobs promise collides with inflation control

Seeking to build on gains in the job market among minority groups in the United States over the past decade, Federal Reserve Chairman Jerome Powell made a landmark pledge in 2020 to try to sustain that progress by giving jobs “of broad-based and inclusive” status equal, if not superior, to the central bank’s promise of low inflation.

However, in a context of price escalation that continues to be pressing, that commitment has received a severe setback. At the December 13-14 policy meeting, Federal Reserve officials acknowledged that the economic slowdown needed to curb inflation also meant that “the unemployment rate for some demographic groups, particularly African-Americans and Hispanics, it would probably increase more than the national average.

It was a stark admission that underscores the dilemma facing the Federal Reserve as it battles the worst bout of inflation since the 1980s and the potential damage to the second objective of its “dual” mandate: full employment in the whole of society.

New data on Friday is expected to show 200,000 jobs were created in December, roughly double what the Federal Reserve considers sustainable, with wages rising and black and Hispanic unemployment rates at rock-bottom levels. historical or close to them. The longer the strength of the labor market persists, the more compelled those in charge of the Federal Reserve will feel to break it with ever higher interest rates.

Tim Duy, chief US economist at SGH Macro Advisors, wrote after Wednesday’s release of December meeting minutes that he said showed the Federal Reserve “willing to bear the costs” of raising the interest rate. unemployment.

“I don’t think we can underestimate the importance of labor market outcomes,” Duy wrote. “If the job market doesn’t slow down noticeably soon, the Federal Reserve will have to raise key interest rates” beyond the 5.00-5.25% range that most officials now see as the breaking point. final.

The federal funds target rate is currently between 4.25% and 4.50%.

“OVERPRICED”

The job market has baffled central bankers during the COVID-19 pandemic as much as inflation. Early expectations that a flood of workers back into the labor market would ease wage and hiring conditions turned out to be optimistic. The labor force participation rate has stagnated below its pre-pandemic level and some officials consider that the supply “seems limited”, according to the minutes of the December meeting.

Even with the uncertainty surrounding the economy, the demand for hiring remains strong. There are still far more job offers than job seekers.

While that’s a potential recipe for steady wage increases, the Fed’s targeting of the labor market as a potential driver of future inflation is not without controversy.

Some economists and monetary policymakers have argued that the roots of inflation lie elsewhere and should not require a sharp rise in unemployment to fix. Fed Vice Chair Lael Brainard has cited, for example, corporate profit margins, which remain high, while Minneapolis Fed President Neel Kashkari recently compared the current dynamics to the kind of “price gouging” ” that companies like Uber Technologies Inc use when high demand meets inflexible supply.

Others argue that a full return to 2% inflation may prove more difficult than expected and the cost to growth and jobs of the final increase may prove too high to bear.

The Federal Reserve itself expects the unemployment rate to rise just one percentage point, to 4.6% from the current 3.7%, by the end of 2023, an increase that would normally be associated with a recession, though not excessively harsh.

The minutes from last month’s meeting, however, may be a warning of what lies ahead, a setback for the job-friendly framework formally adopted by the Federal Reserve in mid-2020 and crafted on the assumption that a market strong labor and low inflation can coexist.

This was the case during the unprecedented expansion that began in 2009 and was still underway when the pandemic struck.

Those responsible then expected inflation to increase for various reasons, from the massive purchase of bonds by the Federal Reserve itself to the constant decline in the unemployment rate. It did not, and it remained so stubbornly low that monetary policymakers worried that the same thing could happen in Japan, where the central bank’s inability to raise inflation to the 2% target presented its own risks.

“SPIRAL OF PRICES AND WAGES”

The new framework was intended to fix this problem with a built-in bias against raising rates until inflation not only returned to, but exceeded, the 2% level, allowing flexible credit to drive the economy, and prices, higher. In theory, the result would be more employment and less unemployment.

This approach, embodied in monetary policy statements in the critical months when rising inflation took hold in 2021, has been criticized for anchoring the Federal Reserve to a course that policymakers were too slow to abandon.

Monetary leaders have acknowledged this, although they have also argued that it would not have made much difference if they had moved against inflation a few months earlier.

What they fear is emerging now is an entirely different problem: inflation that could be fueled by the very labor market conditions they promised to foster.

The notion of a “wage-price spiral” is still disputed, as inflation has so far exceeded average wage gains.

However, as inflation eases from what Fed officials expect to peak in mid-2022, Powell and others expect a moderation in wage increases as well.

The inflation that is proving the most difficult to root out is in the labor-intensive service sector, where prices are more sensitive to workers’ earnings “and therefore would likely remain high.” persistently if the labor market remained very tight,” the minutes state.

“Although there are currently few signs of adverse wage and price dynamics, (monetary policy makers) believe that some moderation in demand growth would be necessary to reduce this component of inflation to levels consistent with the mandate. of manpower”.

This conclusion does not mean that the new framework is given up. In fact, the Fed will almost certainly endorse that approach again at its January 31-February 1 policy meeting. Powell has argued that the best way to fulfill the mandate, in fact, is to rein in inflation now so that a more sustainable labor market emerges.

Even so, it is possible that the immediate conflict between the two is drawing closer.

Samuel Edwards
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