Next Stage of Fed Inflation Fight: Painful Unemployment

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Rates are anticipated to increase by 75 basis points for the third consecutive meeting.

The “pain” that Federal Reserve officials have been predicting in recent weeks is about to become quantifiable when they release updated economic projections. These projections may indicate that the estimated cost of reducing inflation will likely include a significant interest rate increase and unemployment increase.

Following a two-day policy meeting in Washington, where policymakers are anticipated to raise their benchmark rate by three-quarters of a percentage point for the third consecutive time, the US central bank will announce its most recent quarterly predictions on Wednesday.

Due to this action, rates would rise to levels not seen since before the 2008 financial crisis. They will undoubtedly update their predictions since the next stage of the tightening cycle entails increased risks.

Fed expects the unemployment rate to increase once again.

Officials see higher unemployment as a necessary cost of fighting inflation.

The prediction for unemployment in the fourth quarter of this year, 2023, and 2024 made by the median Federal Open Market Committee participant through time are shown in the chart below.

Since the most recent prediction round in June, inflation has barely abated, which has prompted policymakers to adopt a more aggressive position. They are also beginning to question earlier hypotheses about the connection between unemployment and inflation, which may contribute to their current propensity to strive for a more pronounced downturn in economic activity.

“The increasing interest rate trajectory will undoubtedly have a greater impact on unemployment. According to the Fed’s revised prediction, we expect the unemployment rate to be closer to 4.5%, said Brett Ryan, senior US economist at Deutsche Bank AG in New York. They will continue to promote the “soft landing” scenario, but it will include a significant chance of recession.

By the end of 2024, the unemployment rate was projected by most policymakers to rise by a half-point, reaching 4.1%. Monthly figures on consumer prices have been unimpressive since then: According to the most recent data, which the Labor Department released on September 13, annual inflation was still 8.3%.

Meanwhile, Chair Jerome Powell and other officials have increased their public alerts about increasing rates. Powell predicted they would “cause some pain to individuals and businesses” as “the unpleasant consequences of decreasing inflation” in a meaningful address delivered at Jackson Hole on August 26.

What Bloomberg Economics Says: “Be prepared for increased unemployment since it will take further rate rises and a more extended period of restrictive rates before inflation is brought under control. Policymakers will likely consider the terminal fed funds rate’s current market price of 4.4% reasonable.

On September 8, Charles Evans, president of the Chicago Fed, who throughout his 15-year tenure has frequently been viewed as one of the central bank’s more dovish policymakers, expressed optimism that we will be able to navigate this and keep unemployment at about 4.5% by the time we are done, adding that such a scenario “would still be a pretty good outcome, although it will be costly for some.”

However, other data points make the Fed increasingly pessimistic about the future. Additionally, a record amount of job advertisements are helping. Additionally, since June, there has been a growing public discussion about them, which might indicate higher estimates for the unemployment rate that Fed officials believe is consistent with low and stable inflation over the long term.

An increase would represent a substantial shift in the committee’s thinking because their median estimate for that figure has been constant at around 4% since before the epidemic. Powell alluded to the likelihood at a news conference on July 27 when he remarked, “It must have gone up considerably,” given lower rates of job opportunity filling.

The Fed has not yet increased estimates of the long-term unemployment rate.

Higher numbers would indicate a growing influence of job advertising on policy discussion.

Note: The chart displays the US unemployment rate through time and the midpoint of the central tendency of the Federal Open Market Committee members’ projections for the longer-term unemployment rate.

According to the theory, since there are now about two job openings for every unemployed person looking for work, compared to a ratio of about 1.2 in the years prior to the pandemic, the unemployment rate will need to increase more now than it would have needed to then in order to bring the labor supply and demand more into balance and ease wage pressure.

Six million Americans were unemployed and actively looking for work in August when the unemployment rate was 3.7%. Assuming no change in the workforce size, a jump to 4.5% would result in 1.3 million fewer jobs.

Michelle Holder, an economics professor at the John Jay College of Criminal Justice in New York, claims that the suffering won’t be shared equally.

Holder pointed out that during economic downturns, unemployment rates for Black and Hispanic Americans often increase more quickly than those for White Americans. Along with the potential for greater homelessness and hunger among lower-income households, losing a job can have long-term effects on income and employability.

If these estimates have a significant margin of error, Holder expressed his concern that “we are talking about truly turning back fundamental advances in terms of Black employment in this nation.” What the Fed is missing, in my opinion, is the fact that not everyone is experiencing a mild degree of suffering.

https://www.bloomberg.com/news/articles/2022-09-20/fed-set-to-reveal-pain-coming-in-next-stage-of-inflation-fight?srnd=premium&sref=gFEoVT3v

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