The Fed could face an employment problem in its fight against inflation

Construction of residential single-family homes by KB Home is shown under construction in the community of Valley Center, Calif., June 3, 2021.

Mike Blake | Reuters

If the Federal Reserve’s view on inflation wins, a few key things need to move forward, especially when it comes to getting people back to work.

Solving the puzzle of jobs has been the most difficult task for policymakers in the era of the pandemic, with nearly 10 million potential workers still considered unemployed even though the number of open positions has reached a record high. from 9.3 million in April, according to the latest data from the United States Department of Labor.

There’s a pretty simple inflation dynamic at play: the longer it takes to get people back to work, the more employers will have to pay. These higher wages will in turn trigger higher prices and could lead to higher-than-normal inflationary pressures in the longer run that the Fed is trying to avoid.

“Unfortunately, we see good reason to believe that labor force participation may not return to its peak quickly.
pre-Covid level, “said Ian Shepherdson, chief economist at Pantheon Macroeconomics, in a note.” Whatever is going on here, the Fed needs a lot of these people to get back into the workforce in autumn. “

The pace of inflation is of critical importance to the economic trajectory. Too high inflation could force the Fed to tighten monetary policy faster than it wants, causing cascading effects on an economy dependent on debt and therefore strongly linked to low interest rates.

Consumer prices rose at a 5% year-on-year pace in May, the fastest pace since the financial crisis. Economists, however, have generally agreed that much of what is behind the rapid surge in inflation is due to temporary factors that will subside as the recovery continues and the economy will return to normal after the unprecedented pandemic shock.

It is far from certain, however.

The Atlanta Fed’s “sticky” inflation gauge, or the prices of goods that tend not to fluctuate much over time, grew 2.7% year-on-year in May for the strongest growth since April 2009. A separate measure of the “flexible” CPI, or prices that tend to change frequently, rose 12.4%, the fastest since December 1980.

In their most recent forecast, Fed officials put core inflation at 2.2% for 2021 as a whole; Shepherdson said current numbers suggest something closer to 3.5%.

“It’s a huge failure, and it potentially poses a serious threat to the Fed’s benign view of medium-term inflation due to its potential impact on the job market,” Shepherdson said.

What is keeping workers at home

Polls show a variety of factors preventing workers from accepting jobs: concerns child care issues, especially for women, and improved unemployment benefits that are being cut in about half of the states and will expire entirely in September.

From an employers’ perspective, concerns about skills mismatch have persisted for several years and have worsened during the pandemic. For example, a survey by e-learning company Coursera showed that the United States fell to 29th in the world for digital skills needed for entry-level jobs in high demand.

The dilemma is pervasive in American business these days.

All of my clients are struggling to recruit at the levels they need to really get to the other side of this wave.

David Wilkinson

president of NCR Retail

David Wilkinson, president of NCR Retail, the cash register maker that now supplies a variety of products and services to the industry, said he saw “a job crisis” unfolding.

“As labor becomes harder to find, labor becomes more expensive, the other side of the inflationary worry is that as prices rise so does the cost of living. increases and you have to pay people more because they ask for more, ”Wilkinson said. . “All of my clients are struggling to recruit at the levels they need to really get to the other side of this wave.”

Although he believes inflation will eventually come down from its current level, he expects it to be above the 2% that prevailed for most of the post-financial crisis period.

The implementation of technology accelerated during the Covid era. While this continues, Wilkinson said he also expects retailers to pay higher wages to meet the demand for labor.

“We’re seeing an increased focus on the worker in retail, and that’s partly down to the experience, the technology they need to do the job, and partly the willingness to pay,” he said. -he declares. “It brought it back to the fore.”

Managing its way through the various dynamics could prove difficult for the Fed.

Previous attempts to normalize policy over the years have largely failed, with the central bank having to revert to the world of zero interest money printing that emerged during the financial crisis.

“The Fed is trapped,” wrote Joseph LaVorgna, chief economist for the Americas at Natixis and former chief economist for the National Economic Council.

While LaVorgna considers inflation to remain relatively under control, he thinks the Fed may face issues of deflationary pressures. The Fed does not like inflation that is too low because it creates a cycle of low expectations that restricts monetary policy during a downturn.

“Political pressure to do nothing will be intense” as public debt rises, LaVorgna said. “If the Fed can’t (or won’t) remove excessive policy accommodation when the economy is booming, how can policymakers do it when growth consistently slows?”

Markets bet on the Fed

Indeed, the markets are not expecting a big policy move at all.

Treasury yields have in fact fallen since Thursday’s Consumer Price Index report warmer than expected, and market prices are now showing no rate hikes until around September 2022 and a rate of federal funds of only 1% until May 2026.

A report friday from the University of Michigan also showed that consumers are lowering their inflation expectations, with outlook for the coming year at 4%, down from 4.6% in the last survey, and to 2.8% in five years, down from 3% but still well above the Fed’s 2% target.

“Despite all fears that the Fed may have to tighten policy quickly to curb inflation, we think officials will be equally worried about a slowdown in the recovery in real activity,” Pearce wrote, senior American economist at Capital Economics.

The Federal Reserve building is pictured in Washington, the United States on March 19, 2019.

Lea Millis | Reuters

Fed officials will likely talk next week about how the risks are tilted in the current scenario. They were lukewarm about the recovery, continuing to emphasize the role, albeit diminishing, of the pandemic and urging a full political response.

However, if inflation numbers persist on the rise, the pressure to at least curb monthly asset purchases will intensify.

“There has been this debate about whether inflation is different this time around,” said Quincy Krosby, chief market strategist at Prudential Financial. “If inflation rises in a more material and less transient way, consumers are going to need higher wages.”

The Fed is betting that a return to the labor market, especially for women, will make it possible to contain wage pressures and control inflation. The current workforce female participation rate is 56.2%, up from pandemic lows but if not at worst since May 1987.

Regardless of inflationary pressures, the Fed changed its mission statement last year to maintain an accommodative policy until the economy registers inclusive labor gains, i.e. regardless of gender, income and race.

“They will make sure that the descent path to [policy] take off is long, ”Krosby said. “The question is, if inflation picks up more significantly and is stickier, what does the Fed do? This is the concern of the market. “

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