Despite the collapse of Silicon Valley Bank and the shock waves it sent through the banking sector — due, in part, to the bank’s risky exposure to higher interest rates — the Federal Reserve raised interest rates again, the ninth increase in the past year. Jerome Powell, the chairman of the Fed, has made one thing crystal clear: He is not going to let up on his war on inflation. American workers are the inevitable casualty.
“Demand for workers far exceeds the supply of available workers, and nominal wages have been growing at a pace well above what would be consistent with 2 percent inflation over time,” Mr. Powell said in a speech late last year. For that reason, the Fed wants to see “the restoration of balance between supply and demand in the labor market” before it stops fighting inflation. In layman’s terms, that means a restoration of the power imbalance in favor of employers over their workers.
On March 7, Mr. Powell sounded a similar note, declaring that in order to get inflation down to where he thinks it should be, “there will very likely be some softening in labor market conditions.” There’s nothing soft about what he means: less demand for American employees, which leads to fewer raises and more people out of work.
Don’t just take his word for it. In the Federal Open Market Committee’s December 2022 projections, it forecast unemployment increasing by at least one percentage point over the course of this year, which means about 1.5 million people will lose their jobs. Such forecasts, said Skanda Amarnath, the executive director of Employ America, are “an intention to say, ‘This is how we would optimally balance our policy goals,’ and the optimal balancing in their view is a pretty sharp increase in the unemployment rate.”
It’s the kind of increase in unemployment that will probably trigger a recession. There has never been a time in American history when unemployment has increased only by one percentage point and then stopped. Once people start losing their jobs, other businesses become concerned that they will have fewer customers and start making layoffs of their own. A recession quickly follows.
That in itself would seem to fly in the face of the Fed’s dual mandate, which is to pursue not just stable prices but also full employment. Certainly, the Fed will always care about inflation, and it has said it would like to see a so-called soft landing, in which inflation falls without harming the rest of the economy. But “a soft landing that involves millions more people unemployed, is that really a soft landing?” asked Michael Madowitz, the director of macroeconomic policy at the left-leaning Washington Center for Equitable Growth, or is it that “we threw thousands of people out of the plane so it would land lighter?”
Inflation undeniably causes financial pain, particularly for low-income households that have little room to cut back on their spending. But losing a job is far more catastrophic, and the consequences of rising unemployment spread throughout the economy. “The reason people tend to be frustrated by inflation is it eats away at their wage gains,” Mr. Amarnath said. But “the way we’re going to tame inflation is cutting off access to employment and access to a wage increase.”
High unemployment hurts not just the people who lose their jobs. It makes those who stay employed scared to speak out about abuse, demand a raise or risk anything that could cost them their jobs. The ability to leave one employer for another that pays better — one of the few reliable ways Americans have to increase their pay — falls off the table.
Consider what happened in the Great Recession. People who lived in places where the unemployment rate was one percentage point higher than average in 2007 to 2009 were 0.4 percentage point less likely to be employed in 2015. People who enter the job market for the first time in a recession will be paid, on average, 10 to 15 percent less, and the effects can reverberate up to a decade later. “Those who are most impacted by recessions see really long-lasting and devastating consequences,” said Lindsay Owens, the executive director of the liberal think tank Groundwork Collaborative. “They never regain the same level of lifetime earnings or wealth.”
“There’s a perception that unemployment is bad for people who lose their jobs but not for everyone else,” said J.W. Mason, an economics professor at John Jay College at the City University of New York, while “inflation hurts everyone.” But unemployment doesn’t remain siloed and is likely to hurt a lot more than the pinch of higher prices. As Dr. Owens put it, “It won’t be the case that this will feel like a light recession or it will feel like it was worth it to bring the price of milk down a dollar.”
The truth is that the Fed is operating with outdated and rigid ideas about the relationship between wages and inflation. In the decade after the Great Recession, wages grew, and unemployment recovered (albeit much more slowly than it should have) while inflation remained low. “The notion that there’s this exact one-to-one correspondence between wage growth and inflation really doesn’t hold up,” Dr. Mason said.
That’s because there are various ways that businesses can respond to the need to pay higher wages when workers have more bargaining power. The Fed apparently assumes that businesses will always pass the higher costs on as increased prices. But they could instead take a hit to profits — which have been robust in the rebound from the pandemic, in some cases thanks to pricing markups — and devote a larger share of profits to the workers who help generate them. It’s also possible for productivity to increase alongside wage increases, which will expand the economy and head off big spikes in inflation at the same time.
And yet the Fed’s response, kludgy as it is, is to raise interest rates, making it more expensive for businesses to invest, including in their work forces, which is ultimately supposed to stave off wage increases. If a recession causes unemployment, that also will keep wages from rising — because people who lose their jobs have no wages at all and those who don’t won’t have as much bargaining power to demand more. Federal Reserve officials “think that given the current mix of economic factors that they’re looking at, workers need to be on the chopping block,” Dr. Owens said. “They’re going to focus on bringing prices down in the way they know how, with their giant interest rate hammer.”
Since at least the wage-price spiral of the 1970s, the Fed has been “extremely focused on limiting the power of labor,” Dr. Mason said. In 1982 staff members at the Federal Open Market Committee celebrated the fact that “the prolonged period of slack labor markets has paid handsome dividends in an easing of wage inflation.” Paul Volcker, the Fed chairman who brought down double-digit inflation in the early 1980s by engineering recessions, famously carried around an index card showing the schedule of upcoming collective bargaining contracts, and he explicitly saw President Ronald Reagan’s breaking of the Professional Air Traffic Controllers Organization strike as a win in the battle against inflation. “Volcker was very clear that what he was doing required getting negotiated wage settlements down,” said Andrew Elrod, a research specialist at United Teachers Los Angeles who has studied the history of the Fed.
In a paper on the Fed’s policies with regard to unions, Daniel J.B. Mitchell and Christopher L. Erickson noted that when the Teamsters staged a strike against United Parcel Service in 1997, the president of the Federal Reserve Bank of Dallas, Robert McTeer, worried that the settlement they eventually reached would “go a long way toward undermining the wage flexibility that we started to get in labor markets with the air traffic controllers’ strike.”
And yet the Fed’s reasoning — that inflation must be tamed by taming the American worker — doesn’t fit neatly with our current economy. In part that’s because this economy is warped by a pandemic that led to all sorts of unpredictable outcomes. Supply chain snarls drove up the prices of goods when they became scarce, and then price increases shifted to services as businesses abruptly reopened after abruptly shutting down, throwing everything into turmoil. The economy recovered pandemic-induced job losses at a remarkable clip, bringing unemployment to the lowest rate since 1969 in January, but that led to a temporary surge in demand. Working from home has changed rental markets for offices and homes. Russia’s invasion of Ukraine drove up energy prices.
The labor market has proved remarkably resilient, but workers still have catching up to do from their pandemic losses. We’ve recovered all the lost jobs but haven’t created all the jobs we were on track to produce before it happened. People in their prime working years are finally back in the labor force at the same rate as before, but that rate would have kept increasing without the crisis. Even without the recent bank runs, the recovery is still fragile. “We’re at risk as long as the Fed is saying the unemployment rate has to go up,” Mr. Amarnath said.
“Even if the labor market is not the cause of inflation, we’re using the labor market as the offsetting mechanism,” Mr. Amarnath added. “It’s a very perverse and collaterally damaging approach.”
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