Because unemployment is low that means that the Fed can't drop rates at all or else inflation will come back. And it is likely that if the Fed pauses rate hikes and the economy doesn't fall into recession that there will be another boom and high inflation again, which will kick off more rate hikes. This is the difference between short-term reactions of inflation to rates and long-term reactions.
What the Fed needs to meet its goals is unemployment running at 6-8% so that there's slack in the labor market. Until that happens, inflation will persistently come back. That implies that the Fed must create a recession to increase unemployment before it meets its goals.
And I suspect that it will be sufficient for the Fed to maintain rates at roughly where they are for 6-12 months in order to achieve a recession. We've spent way too long on cheap rates and there's too many zombie investments that require borrowing at stupidly low rates. When those loans adjust to higher rates and the borrowing costs of those entities double or triple (just like an ARM) those entities should all go under. You don't have to look past the vacancies in the malls and downtown cores of cities.
my view of "everyone is probably wrong" is how much everyone is predicting a soft-landing or mild recession in the US (including the title article, which is a good gauge of the centrist position). Rates are already at a level where they should cause detonations in the US economy -- it will just take 6-12 months at these current levels (and historically recessions that followed rate hikes have happened after 6-12 months -- there are time delays in the system).
Wage growth is not driving inflation. Pushing unemployment higher isn't the route to fix inflation.
Recent inflation was driven primarily by two things significant increase in energy costs. Just like in the the 70s large oil spikes will drive large inflation as the cost of everything requires energy.
Second was sever supply constraints due to lack of labor due to Covid (either people out side, plants running minimally, or older people retiring, or deaths). Labor force participation rates dropped 2% world wide 3% in the use. Overall labor force participation has been slowly decreasing over time (due to countries moving up the development index), but that was roughly a decade worth of gradual reduction that just dropped overnight due to Covid. Supply became severly constrained for the same number of people. Increasing unemployment will only make the situation worse.
Look at world labor force participation rate [1], it still hasn't recovered raising unemployment will only make it worse. Or look at US which dropped almost 3%.
What needs to happen is that needs to recover. It started recovering slightly but still not back to the level it needs to be. That's what will fix inflation, increasing production of goods and services, not restricting them more.
What will increase labor force participation? Increasing wages. For almost-retirees, those with deciding whether to work or not wages aren't sufficient to incent them to do so. Raising wages would bring people back into the labor force (without causing inflation in real terms). Capital is taking such a large portion of the gains of productivity in high productivity countries that wages aren't drawing in people to work. Increase the wages and that will fix itself. That started to happen and the economy started rebalancing, and then govts began stepping in to halt it. As a result the are pushing us towards lower production with supply shortages (more or less stagflation).
I guarantee you that the top graph there of how wage growth is running is what is most concerning the Fed when they talk about inflation.
We had commodities inflation during the last oil spike around 2010-2014 and the Fed didn't care about that. They know that commodities inflation acts as a tax and a natural brake on the economy and is cyclical in nature, so they didn't act. It didn't show up in wage growth.
We have both acting together right now, but it is the wage growth portion that the Fed is reacting to.
And here's a good short reaction article to Jerome Powell's comments earlier this month:
> “We’ve made less progress than expected on inflation,” Powell said.
compared to:
> The Labor Department’s consumer price index shows that, on average, prices have risen just 0.2 percent during the last five months — a stark turnaround from the high of 1.3 percent in June
The Fed is not as trivially stupid as the portrayal of the person who can't get past the y-o-y inflation headlines. They understand that CPI inflation is down. Oil and gas prices are back down. Why are they still yapping about less progress than expected keeping inflation under control? They're not pants-on-head stupid. Their definition of inflation encompasses wage growth (and I'd argue that in fact that is the definition of inflation that they are MOST concerned about) and isn't any of the CPI numbers.
And you can read this concern directly from Powell's remarks:
> Despite the slowdown in growth, the labor market remains extremely tight, with the
unemployment rate near a 50-year low, job vacancies still very high, and wage growth elevated.
Job gains have been robust, with employment rising by an average of 272,000 jobs per month
over the last three months. Although job vacancies have moved below their highs and the pace
of job gains has slowed from earlier in the year, the labor market continues to be out of balance,
with demand substantially exceeding the supply of available workers. The labor force
participation rate is little changed since the beginning of the year
> [...]
> The third piece, which is something like 55 percent of the
index, PCE core inflation index, is non-housing-related core services. And that’s really a
function of the labor market, largely. The biggest cost, by far, in that sector is labor. And we do
see a very, very strong labor market, one where we haven’t seen much softening, where job
growth is very high, where wages are very high. Vacancies are quite elevated, and, really,
there’s an imbalance in the labor market between supply and demand. So that part of it, which is
the biggest part, is likely to take a substantial period to get down.
> The other—you know, the goods inflation has turned pretty quickly now after not turning
at all for a year and a half. Now it seems to be turning. But there’s an expectation, really, that
the services inflation will not move down so quickly, so that we’ll have to stay at it, so that we
may have to raise rates higher to get to where we want to go. And that’s really why we are
writing down those high rates and why we’re expecting that they’ll have to remain high for
a time.
Typical targets for “full employment” are around 4%. 6-8% is not only unnecessary but contrary to the Fed’s other raison d’etre (besides combatting inflation) of full employment, which includes combatting higher unemployment than is necessary.
Increasing interest rates has systemic effects that take a while to propagate. We have already seen this reflected in CPI (which is also partially due to stabilizing after the supply shock of the war in Ukraine), and unemployment may get a bit worse than it is now, but the Fed absolutely will not want to increase unemployment into the ranges you mention unless absolutely necessary to combat inflation, because it’s contrary to their goals.
You should say more about why you think 6-8% unemployment is required. From September 2014 - February 2020, unemployment was below 6% without signs of significant inflationary pressure.
I'm not saying you're wrong (those periods are different from the present in a lot of ways), just that your reasoning isn't very apparent.
I didn't say that inflation would reappear at 5.99% unemployment.
They need >6% so there's a gap between here and there. Right now we're clearly at the rail and unemployment has not budged. The jobs overhang has significantly abated, but that has been a short-term reaction to the policy changes, and it can change back on just as short of a term.
> I didn't say that inflation would reappear at 5.99% unemployment.
I didn't say you did, just that you haven't said anything to motivate the 6-8% number. It's plausible sounding, but as far as what you've said so far, you might as well have drawn those numbers out of a hat.
Because it took 5 years from 2015-2020 for unemployment to fall from 6% to 3.5%, and during that period wage growth was between 3% to 4.5%, which is consistent with the Fed's desire to keep wage growth in line with their 2% inflation target adjusted for productivity gains.
The 8% number is motivated by the fact that the economy is highly nonlinear and the Fed really doesn't control how bad the next recession is going to be. It could, of course, be even worse.
I'm not a financial person so help me understand. Is it a requirement for the current financial system to maintain an unemployment rate in a certain range (be it 6-8% or something else) in order to keep functioning and not spiral into an inflation death cycle? What happens if we have an unemployment rate close to 0?
The 6-8% isnt necessarily a requirement, but its a tool to reduce the amount of money flowing through the economy. What is a requirement is a boom-bust cycle.
We have very clearly just found the lower limit on unemployment which will then produce inflation. We're never going to hit a limit of 0%, there will always be people who are getting fired, and some people who are pretty unemployable. The limit will also change based on conditions and the lower limit from decades ago or decades in the future may be different from today. There's no known good algorithm to tell you what that magic number is.
I'd also argue that "inflation death cycle" packs a lot of negative political assumptions into it. And the "death spiral" economists were typically worried about decades ago was the deflationary death spiral of savings gluts causing deflation causing more savings.
And my assertion is that "the Fed conquering inflation" cannot be read off of the CPI numbers for the past 6 months. We're still at what the Fed would call "full employment" and inflation is lurking and all we've seen is a short term abatement in inflation. If the economy revvs up again, then in the short term the curve will be the same and inflation will reappear.
For the Fed to consider the job done the curve needs to move so that the economy can rev up again without inflation reappearing. That will only happen if there's more slack in unemployment numbers. If we are at 6-8% unemployment then it will take time for the unemployment rate to fall back down to 3.5% and for inflation to reappear. By creating more unemployment you shift the curve so that the economy can run hot for awhile and grow while keeping wage inflation down. So shifting that curve is what the Fed's actual goal is, they're looking beyond what last months inflation numbers were (and they look not only beyond the y-o-y headline inflation numbers but they look beyond the m-o-m inflation numbers). They want to shift the curve, and the way to shift the curve is to have more slack in the jobs markets, which is economist-speak for a higher unemployment rate.
They also will very likely overshoot whatever target they think they have, they don't have a magic wand to control the economy. They mostly just detonate a few bombs in the economy and they don't know how much dry powder is waiting to go off in secondary explosions. Or the way this is usually phrased, "when the tide goes out we find out who was swimming naked".
And there's a tension here in HN between the oft stated belief that a decade of low rates has led to all kinds of malinvestment, and the belief that we're due for a soft-landing kind of recession. One of those I think has to be incorrect. And looking at the vacancy rates in downtown cores, etc I'm pretty sure the soft-landing story is going to be the wrong one. There are a lot of entities surviving on persistently low short rates, and they're going to go under once their loans adjust. The strict capitalists will celebrate this as bad investments going under and getting flushed, but that comes with pain, just like it was painful in 2008.
I'm not going to argue that 3.5 unemployment is compatible with low inflation, but I don't think we've found the limit per se--inflation started rising in 2021 well before unemployment was so low, and there have been huge supply shocks as well.
What the Fed needs to meet its goals is unemployment running at 6-8% so that there's slack in the labor market. Until that happens, inflation will persistently come back. That implies that the Fed must create a recession to increase unemployment before it meets its goals.
And I suspect that it will be sufficient for the Fed to maintain rates at roughly where they are for 6-12 months in order to achieve a recession. We've spent way too long on cheap rates and there's too many zombie investments that require borrowing at stupidly low rates. When those loans adjust to higher rates and the borrowing costs of those entities double or triple (just like an ARM) those entities should all go under. You don't have to look past the vacancies in the malls and downtown cores of cities.
my view of "everyone is probably wrong" is how much everyone is predicting a soft-landing or mild recession in the US (including the title article, which is a good gauge of the centrist position). Rates are already at a level where they should cause detonations in the US economy -- it will just take 6-12 months at these current levels (and historically recessions that followed rate hikes have happened after 6-12 months -- there are time delays in the system).