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The Federal Reserve Is Coming For Your Next Raise

by Index Investing News
October 20, 2022
in Uncategorized
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As the Federal Reserve fights rising prices, its efforts will be felt not just by borrowers and bond traders but also pretty much anyone who works for a living.

The central bank has been raising interest rates, making money more expensive to borrow, in a bid to slow down the whole economy so people don’t spend so much. That way, businesses will offer lower prices.

Part of the solution involves what Fed Chair Jerome Powell calls “softening of labor market conditions.” That softening, as Powell and his colleagues envision, will involve higher unemployment in the coming year.

But Fed officials speak in abstractions, discussing supply and demand or the importance of righting imbalances between the two, while avoiding talk about the material consequences for workers.

“The language that’s used to talk about monetary policy is almost designed to make it less clear what actually is at stake and what the real goals are,” said J.W. Mason, an associate professor of economics at the City University of New York’s John Jay College of Criminal Justice.

Powell has acknowledged that there will be some “pain” in the Fed’s campaign against inflation, maybe to the point of recession. But even workers who stay employed will feel the impact of increased interest rates.

“The only way in which higher interest rates reduce inflation is by raising unemployment and thereby inducing workers to accept lower wages,” Mason said.

Wage growth accelerated this year to the fastest pace in more than two decades, but overall the gains haven’t kept pace with rapidly rising prices for consumer goods. Powell has described stable prices as a necessary ingredient for a healthy economy.

The nominal wage growth occurred amid an economywide mismatch between supply and demand that economists say resulted from supply problems, such as COVID-19 lockdowns in China and the war in Ukraine, and also strong pandemic relief policies.

The Fed can’t do anything about the supply issues, but Powell has said it will keep pushing down on demand until inflation abates. So far, the Fed’s historically rapid rate increases this year haven’t done the trick, with overall inflation still flying high at 8.2% as of September, while unemployment remains at a historically low 3.7%.

The Fed’s policymakers have said they expect unemployment to rise to 4.4% next year as a result of their actions, implying that millions of additional workers could face unemployment. Increasing the size of the jobless population would likely mean that more people would be willing to work for less pay.

Powell has suggested that workers are too strong right now, describing the current power dynamic as out of whack with what the Fed would consider a better balance between bosses and employees.

“You have two job vacancies, essentially, for every person actively seeking a job, and that has led to a real imbalance in wage negotiating,” Powell said at a press conference in June.

With a more “normal” ratio of job seekers to openings, Powell said, “You would expect to see those wage pressures move back down to a level where people are still getting healthy wage increases, real wage increases, but at a level that’s consistent with 2% inflation.”

“The only way in which higher interest rates reduce inflation is by raising unemployment and thereby inducing workers to accept lower wages.”

– J.W. Mason, an associate professor of economics

Powell has outlined a “soft landing” scenario in which businesses cut the record supply of job openings without losing too many actual jobs. So far, the strategy could be working, since the number of openings fell by a record 1 million in September, while unemployment ticked up slightly. The rapid decline in openings could also be a signal that the Fed’s rate increases are working better than expected, and that it should wait to do more.

The ultimate magnitude of job losses, Powell said last month, will depend partly “on how quickly wage and price inflation pressures come down.”

Mason doubts that lower wage growth is actually necessary for lower inflation, since he does not think higher wages cause higher prices. For one thing, companies paying increased wages could simply accept lower profits instead of hiking prices. But corporations have been jacking up prices while raking in record profits.

Fed Vice Chair Lael Brainard, one of the more dovish members of the central bank’s board of governors, suggested in a speech this month that businesses might hesitate to lay off workers after complaining of a labor shortage for the past year. And she said companies could stand to reduce prices, noting that profit margins in some retail sectors have exceeded compensation cost increases.

“The return of retail margins to more normal levels could meaningfully help reduce inflationary pressures in some consumer goods, considering that gross retail margins are about 30 percent of total sales dollars overall,” said Brainard, according to a transcript of her remarks.

Some Democrats in Congress have talked about imposing price controls or taxing windfall corporate profits, but for the most part lawmakers have ceded the inflation fight entirely to the Fed.





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