Federal Reserve Chair Jerome Powell said pain would be necessary to quell inflation. It’s looking increasingly likely that won’t be the case.
At 3.7%, the unemployment rate is right about where it was when the Fed began raising interest rates in March 2022. Meanwhile, the pace of inflation’s descent — which has left it now only a percentage point above the central bank’s 2% target — has also surprised policymakers, just as it did on the way up.
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That combination of trends, provided it persists, is sure to fuel debate among central bankers over key takeaways from the pandemic experience.
“It’s really important to broaden the framework out, so that you’re not just relying on these ridiculously simplistic macro models that lead central bankers to conclude their trade-offs are pain or more pain,” said Julia Coronado, president of MacroPolicy Perspectives.
Each quarter, Fed officials release projections about the path for unemployment, inflation and interest rates in the years ahead. In September, they reduced their projection for where the unemployment rate was likely to stand at the end of 2024 to 4.1% from 4.5%, according to the median estimate.
A similar unemployment figure in the latest set of projections to be released Wednesday, or a downgrade to their projection for inflation next year, would indicate a solidifying expectation among policymakers that the pain they had previously warned of will largely be avoided.
Such a move would follow a similar evolution among the Fed’s staff economists, who went from predicting a recession in March to abandoning that call in July. By September, the staff had decided that the unemployment rate would “remain roughly flat” over the next few years, according to minutes of that month’s policy meeting.
The change of tune comes amid a swift moderation of inflation this year that economists inside and outside the Fed have widely attributed to improvements on the “supply side” of the economy, as businesses have adapted to supply-chain bottlenecks in product markets created first by the pandemic and then the Russia-Ukraine war.
Meanwhile in the labor market, many have cited a resumption of immigration to the US that has made it easier for businesses to hire. Other pandemic-related labor-market disruptions have receded further into the rearview mirror as well, supporting workforce participation and helping to curb upward pressure on wages.
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“In the midst of what was a high-churn, high-turnover, hot-hiring economy, there probably were some one-time strains on search costs, and that probably did push up wages on a one-time basis,” said Skanda Amarnath, executive director of Employ America, a think-tank that supports pro-labor policies. “So wage growth went up and wage growth went down, even though unemployment largely stayed in the same spot.”
Powell, for his part, has continued to indicate that further improvements to inflation may require the Fed to apply more downward pressure to the “demand side” of the economy, which could result in more job losses than currently expected.
Still, he’s tempered that message compared with last year, when he first began warning of the “pain” that would be involved.
“I think everyone has been very gratified to see that we’ve been able to achieve pretty significant progress on inflation without seeing the kind of increase in unemployment that has been very typical of rate-hiking cycles like this one,” the Fed chair told reporters on Nov. 1, after the central bank’s last policy meeting.
Fresh Data
Since then, the favorable inflation and labor-market news has continued.
Government data out last month showed the Fed’s preferred inflation metric excluding food and energy moderated to 3.5% in the 12 months through October — on track to beat policymakers’ September projections for 2023. Separate data published Tuesday showed another key gauge of underlying inflation fell below 3% on a six-month annualized basis for the first time since 2021.
Meanwhile the latest monthly employment report, published Dec. 8, showed the unemployment rate dropped amid strong job creation.
“Economists who’ve said it’s going to require very high unemployment to get this done are eating their words,” Treasury Secretary Janet Yellen said last week. “It doesn’t seem at all like it’s requiring higher unemployment.”
Not all are convinced the job market can remain robust through this last stretch of disinflation. Bloomberg Economics, for instance, believes a recession is likely already underway as a consequence of the tightening the Fed has done so far.
“Because job creation was limited to recession-proof sectors, the implied underlying pace of job growth is in fact much weaker,” Bloomberg economists, led by Anna Wong, said following the latest jobs report. “Our view is that the data don’t provide firm evidence against our recession call, and the Fed remains likely to begin cutting rates in March 2024.”
This article was provided by Bloomberg News.