The Federal Reserve needs to cool off the overheated labor market to tame inflation, though it’s not clear how far unemployment must rise to achieve that, according to former Fed Chair Ben Bernanke and ex-International Monetary Fund Chief economist Olivier Blanchard.
While a steep run-up in goods prices was the main impetus to the surge in inflation over the last 2 1/2 years, the impact of a “very tight” job market is growing and is likely to prove more persistent, they wrote in a paper to be presented at the Brookings Institution on Tuesday.
“Controlling inflation will thus ultimately require achieving a better balance between labor demand and labor supply,” the two economists said.
US unemployment fell to a multi-decade low of 3.4% in April from 3.5% in March, while payroll growth picked up to 253,000 from 165,000. Inflation, meanwhile, is more than double the Fed’s 2% target.
In a separate paper for Brookings, former Fed Vice Chair Donald Kohn and Brown University professor Gauti Eggertsson argued that the Fed’s adoption in 2020 of a flexible average inflation target – and the forward guidance it gave to back that up – delayed the central bank’s response to the price pressures that developed subsequently.
The delay “may have contributed to the inflation surge, and forced a more abrupt tightening that might have contributed to financial instability and eroding confidence in the central bank,” they wrote.
Under the 2020 framework, the central bank shifted its focus from trying to contain inflation at 2% to actually fostering it, with the explicit objective of having it run moderately above that pace for a time to make up for years of being below it.
The argument that Bernanke and Blanchard lay out in their paper about the evolution of inflation jibes with that put forward by Fed Chair Jerome Powell last week.
In a joint appearance with Bernanke at a May 19 Fed conference, Powell played down the significance of the job market in the 2021 inflation spike.
“By contrast, I do think that labor market slack is likely to be an increasingly important factor in inflation going forward,” Powell said.
As he has before, Powell zeroed in on the persistence of inflation in a grab bag of services — everything from health care and education to haircuts and hospitality — where labor costs are a high proportion of the cost of doing business.
Powell gave a clear signal at the conference that he is inclined to pause interest rate increases next month, saying the Fed has already tightened credit a lot and thus could now afford to look at how the economy evolves.
The Fed chair has previously voiced hopes that the labor market can be brought into better balance more through a drop in job vacancies than through a big increase in unemployment.
Job openings fell to 9.59 million in March, from 9.97 million in February and 12.03 million in March 2022, according to Labor Department data.
“With labor-market slack still below sustainable levels and inflation expectations modestly higher, we conclude that the Fed is unlikely to be able to avoid slowing the economy to return inflation to target,” Bernanke and Blanchard wrote in their paper.
“The extent of that slowing will depend however on the evolution of certain structural features of the labor market, notably the efficiency of the process of matching workers with jobs,” they added.
Bernanke and Kohn are currently senior fellows at Brookings while Blanchard holds that post at the Peterson Institute for International Economics.
This article was provided by Bloomberg News.