Paul Krugman has forwarded an excellent blog piece by Roosevelt Institute Fellow Justin Bloesch on why we can maintain near-full employment while inflation is returning to the rate that prevailed prior to the pandemic.
Bloesch maintains that full employment and 2 percent inflation rates are possible because there is no longer a higher “natural rate” of unemployment that the Fed must maintain to bring down inflation.
The Fed believes that the best way to bring down inflation is to slow economic growth by inducing lower consumer spending and capital investment by continuing to boost their short-term interest rate target to somewhere between 4.5 to 5 percent.
But the current 3.5-3.6 percent unemployment rate has prevailed since March 2022 even while wage growth and consumer spending have been slowing that are the major ingredients of inflation.
Top that off with supply-side bottlenecks already easing and commodity prices falling, leading us to believe that inflation will return to more historical levels by the spring of 2023.
The probability of such a return to more historical inflation levels of 2-3 percent that prevailed since the 1990s is further increased should the Ukraine War quiet down and China get its post-pandemic COVID problems resolved.
Justin Bloesch’s graph shows that COVID’s shock to the employment system was uniform across all sectors, and the post-pandemic recovery has been uniform across all job sectors as well. This suggests that the COVID pandemic was the main cause of the inflationary surge, and as infection rates continue to decline, more people will want to return to work, keeping unemployment low, and lowering the pressure for employers to raise wages further.
“The better explanation for a temporarily high V/U ratio (i.e., job vacancy to unemployment), and the overall high level of churn in the economy, is just that the economy was rapidly emerging from the pandemic. Many workers did lose their jobs and took jobs in new sectors, and demand for labor was both high and growing rapidly,” said Bloesch. However, as the economy shifts to a slower pace of growth, it is likely that recruiting activity can fall without triggering layoffs.”
This is while the Fed seems to believe that we can’t maintain full employment and a tight labor market without pushing wages even higher, as employers compete for scarce workers.
We have had lower inflation during the last few decades, an era labeled the “great moderation” by economists, because of modern technologies like speeded up just in time supply chains and improved production facilities jn many Asian and third world countries that created an excess of goods and services worldwide.
Harvard Professor Jeffery Frankel, a member of President Clinton’s Council of Economic Advisors, sees commodity prices in particular continuing downward in a recent Project Syndicate article because of the current economic malaise.
“There are two macroeconomic reasons to think that commodity prices in general will fall further. The (slowing) level of economic activity is a self-evidently important determinant of demand for commodities and therefore of their prices. Less obviously, the real interest rate is another key factor. And the current outlook for both global growth and real interest rates suggests a downward path for commodity prices.”
So there doesn’t have to be such a draconian tradeoff between what has been called a “natural rate” of unemployment and inflation. In fact, the relationship between employment and inflation seems to have created a lower “natural rate” than the Fed and many forecasters are using to determine what is the ideal interest rate target the Fed should be shooting for.
This is important and might prevent the large number of layoffs the Fed is expecting because of their current policies, given today’s market conditions in a fast-changing world.
Tomorrow’s release of the government’s first estimate of Q3 GDP growth may give us a hint of what kind of slowdown we are already experiencing.
Harlan Green © 2022
Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen
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