“Unless we have a very surprising and positive set of developments,” Summers told POLITICO, “we probably won’t see the inflation rate come down to [the Fed’s] target without some level of significant economic distress. Summers, who was also a top White House adviser to Obama, called the Fed’s earlier forecast “outrageous.”
The result has far-reaching implications for the country, including countless American families who have benefited from an extraordinarily strong labor market, but who have also grappled with historic price spikes that have swallowed up wage increases. and weighed on household budgets. It also presents a huge challenge for Joe Biden’s presidency, as a miscalculation by the Fed could lead to an economy in a dive, persistently high inflation, or worse, both.
While the Fed in June saw the jobless rate hit 4.1% by the end of 2024, some economists say it may need to rise to nearly 6% and stay there for a while to drive down unemployment. inflation – an increase that would undoubtedly coincide with a recession.
Diane Swonk, chief economist at KPMG, said it was no longer a question of whether the Fed could avoid a recession, but whether it would accept a mild slowdown that would slowly reduce inflation, or a deeper slowdown that would work quickly.
“The Fed’s optimal scenario is that we get there with only a modest increase in unemployment,” Swonk said. “I think within the Fed there is some recognition that it may have to be more than that.”
Still, there are already signs that the labor market is starting to cool, which could relieve pressure on the Fed to keep raising rates as aggressively as it has been. Job postings in July fell to 10.7 million, the lowest level in nine months but still at an all-time high. And average monthly job growth over the previous three months stabilized at 375,000 in June, from 539,000 in the first quarter of the year. The Labor Department will release new hiring data Friday morning.
More broadly, economic activity has slowed markedly. The government said last week that gross domestic product fell in the second quarter, after falling in the first three months of the year, raising concerns of a looming recession.
Meanwhile, Powell is under pressure from some leftist economists and politicians, such as Sen. Elizabeth Warren (D-Mass.), who argue that the Fed’s campaign to raise interest rates will do little to stifle inflation that is largely driven by supply shocks like the war in Ukraine and the Covid lockdowns in China. In a Wall Street Journal op-ed last week, Warren also called Summers a “cheerleader” for higher rates and “someone who never worried about where his next paycheck was coming from.” “.
Other skeptics say it’s up to the Biden administration and Congress to do more to help the Fed get prices under control and avoid derailing the economy.
“A recession won’t help us fight inflation – a recession will only hurt working families,” the senator said. Sherrod Brown (D-Ohio), chairman of the Senate Banking Committee. “We need to drive down prices for workers and families, and fight inflation at its source – that means fighting rising prices and business consolidation, expanding our housing supply and investing in our supply chains. supply.”
Democrats are set to advance legislation soon, brokered by the Senate Majority Leader chuck schumer and sen. Joe Manchin (DW.Va.), which they say would help ease price pressures by reducing federal budget deficits — although some forecasters believe the effect on inflation would be small and not materialize right away .
Powell says the Fed doesn’t have the luxury of ignoring supply constraints and hoping inflation goes down on its own. And he stressed that policymakers will not back down from slowing growth or a slowing labor market as they continue to hike rates.
“These are things that we expect, and we think they are probably necessary … to be able to get inflation back on the 2% path and eventually get there,” he told a conference. press last month.
How much pain will it take?
Summers likened the process to being a drug addict in rehab – it will involve withdrawal symptoms. For now, the Fed still expects those symptoms to be mild, although Powell acknowledges that the path to avoid recession has narrowed.
In June, Fed officials forecast inflation to rise from around 5.2% at the end of this year to just above their target of 2% by the end of 2024. At the same time , they expected the unemployment rate to rise by only half a percentage point. point, at 4.1% against 3.6% in June.
Part of their optimism reflects officials’ view that a decline in job vacancies could provide some relief to the labor market and help ease price pressures without raising unemployment too much.
As the economy slows, employers typically give up hiring and start laying off. But with so many vacancies relative to the supply of available workers, Fed officials expect that a drop in job openings won’t necessarily correspond to such a large rise in the jobless rate this time around. .
Not everyone is convinced.
In an article published last month, former International Monetary Fund chief economist Olivier Blanchard, Harvard researcher Alex Domash and Summers said the Fed’s hope “runs counter to theoretical and empirical evidence. “. Looking at labor market data since the 1950s, there has never been an example where the job vacancy rate has fallen substantially without a significant increase in unemployment, they wrote.
“Tackling inflation will require decreasing job vacancies and increasing unemployment,” they wrote. “There is no magic tool.”
Furthermore, the so-called natural rate of unemployment — the rate at which economists believe unemployment begins to fuel higher inflation — is much higher than it was before the pandemic, they argued. That means the labor market is even tighter than many realize, and the jobless rate will need to rise far more than the Fed expects to bring inflation down, they wrote.
Fed Economist Andrew Figura and Governor Chris Waller pushed back in a blog post on Friday, saying a soft landing is still possible. They acknowledged “it would be unprecedented for vacancies to drop significantly without the economy falling into recession”, but said it was an unprecedented situation.
The problem is that the Fed doesn’t have precise tools to target a particular vacancy rate or unemployment rate to slow the economy just enough to bring down inflation. And he doesn’t have a “recession” button that he can push even if he wanted to.
This increases the risks that the central bank will raise rates too high, causing a painful contraction and potentially pushing inflation too low, said economist Wendy Edelberg, director of the Hamilton Project at the Brookings Institution.
The biggest worry, she added, is that the economy is slowing and inflation remains high. This could happen if inflation expectations start to rise or if supply shocks continue to hit the economy.
There’s still the possibility that a recession won’t be necessary if supply constraints start to ease, said Claudia Sahm, a former Fed economist. “If we don’t fix the supply issues, we need to see consumers slow down their spending,” she said. “Growth needs to slow, business investment is slowing. Things just need to get a little cooler.
But ultimately what the Fed wants to see is lower inflation — and it’s up to Powell and his colleagues to decide how fast they want that to happen.
“If they want 2% and they want it now, they can get it,” she said. “But then to get it, we would need a recession.”