The Fed has decided the US will need a 'growth recession' to rein in inflation. Here's why it's bad news for job-seekers.

Jerome Powell, the Federal Reserve chair, said on August 26 that cooling inflation would “bring some pain” to Americans.REUTERS/Jonathan Ernst

  • The chance of an economic “soft landing” has faded, and the Fed is pushing for a “growth recession.”

  • The phrase describes a period of below-average growth, rising unemployment, and slowing inflation.

  • The Fed chair said that while it’d “bring some pain,” letting inflation stay high would be worse.

In an ideal world, the Federal Reserve has already vanquished pandemic-era inflation while keeping unemployment at historic lows and avoiding a recession.

Hopes for such an outcome are all but entirely dashed, and the Fed has switched to plan B.

The central bank’s message at its annual conference in Jackson Hole, Wyoming, this year was a simple and stark one. In remarks on August 26 that lasted less than 10 minutes, Jerome Powell, the Fed’s chair, warned that cooling inflation would “bring some pain” to Americans through layoffs, weaker pay growth, and higher borrowing costs. He said that while the side effects are “unfortunate,” a failure to slow price growth and normalize the economy “would mean far greater pain.”

The speech laid to rest the idea that the US can enjoy a so-called soft landing, in which the Fed can bring inflation back to its 2% target without driving up unemployment. The central bank has been raising interest rates at the fastest pace since the 1980s in an attempt to ease Americans’ demand and slow inflation. Powell clarified in the speech that additional rate hikes are on the way, further eroding optimism for a soft landing.

In its place is the likelihood of a “growth recession,” which describes a period of slow economic growth and higher unemployment. It’s not quite stagflation, as that scenario requires high inflation in addition to those two conditions. But it’s a brute-force way to stamp out inflation, and Powell’s remarks signal it’s what the Fed is turning to after more than a year of faster-than-usual price growth. Americans about to return to the labor market and look for a new job are going to feel the brunt of the pain.

“Reducing inflation is likely to require a sustained period of below-trend growth,” the chair said, adding that there “will very likely be some softening of labor-market conditions.”

Jobs will suffer the most in a growth recession

The Fed has targeted the labor market as a key battleground for fighting inflation, and Powell has cited the massive imbalance of worker supply and labor demand. Government data published last week indicated the US was still touting roughly two job openings for every available worker, underscoring just how tight the labor market has become.

“Softening” that pocket of the economy would translate to serious discomfort for many working Americans. Higher interest rates tend to slow companies’ hiring plans as they shift toward protecting profits and cutting costs. Waning demand for workers can lead to smaller pay gains, as firms don’t have to compete as aggressively to hire.

A growth recession could even drive the unemployment rate sharply higher if enough companies lay off workers to bolster their balance sheets. The rate sits at 3.7%, just a hair above the five-decade low seen before the pandemic. A swift easing of labor demand could put Americans out of work at a time when firms are no longer hiring at the voracious pace they’ve kept up throughout the past year.

Joe Brusuelas, the chief economist at the consulting firm RSM US, said soon after Powell’s speech that it’d be tough to get inflation lower without “triggering a recession” and losing 5 million to 6 million jobs. “That is about as close as one may get to what can charitably be called a soft landing,” Brusuelas said.

The economies of the mid-1980s and mid-1990s offer some clues about what growth recessions look like. The former followed a historic inflation spell that required the Fed — then chaired by Paul Volcker — to raise interest rates to record highs. While that worked to cool price growth, the economy expanded at a below-trend pace. The unemployment rate didn’t surge, but it lingered at elevated levels for several years before resuming its downward trend.

The economic expansion of the mid-’90s was similar, featuring easing inflation, below-average growth, and stubbornly high unemployment. The economic expansions that came after both growth recessions were healthy but still included some scarring from the few years prior.

The latest growth recession is already emerging

Employment data published Friday offered the first sign that the economy is settling into its phase of slow growth and rising unemployment. The economy added 315,000 jobs in August, barely surpassing the median forecast but slowing significantly from the July increase of 526,000 nonfarm payrolls.

The June and July gains were collectively revised lower by 107,000 jobs. Though job creation remains extraordinarily strong, the August data hints that the months of above-trend growth are coming to an end.

To be sure, the uptick in the unemployment rate came from an encouraging trend. Labor-force participation — which tracks the share of Americans either working or actively seeking work — edged higher last month, to 62.4% from 62.1% in July, signaling that more workers came off the labor market’s sidelines. Since the headline unemployment rate counts only participating Americans who aren’t working, the gain in participation drove the measure higher.

Still, the jobs report perfectly matches the kind of economy the Fed aims to usher in. Higher interest rates would curb job creation further, especially as rates rise to levels considered restrictive to the overall economy. Easing demand for workers would also slow the pace at which newly participating Americans can find jobs.

The “softening” Powell spoke of weeks ago is on the horizon, and with it will likely come higher unemployment, cooler inflation, and a period of below-potential growth.

Read the original article on Business Insider

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