Unemployment Is Low. Inflation Is Falling. But What Comes Next?

The U.S. Economy is being viewed in two very different ways: by what the data shows has happened over the last few months and what history predicts will happen next.

Recent data indicates that the economy has been strong. It is incredible that the job market today is better than it was back in February 2020 before the coronavirus epidemic ripped a hole through the global economy. There are more people working. The pay is higher. There are fewer gaps in income, race, gender or education.

Even inflation, the long-time black cloud that hung over the sunny economy, is beginning to dissipate. Data released by the government on Wednesday revealed that consumer prices rose 5 percent from a month earlier in March, which is the lowest rate in almost two years. Prices have increased at a rate of 3.8 percent per year over the last three months. This is faster than policymakers had hoped, but not as fast as they would have liked.

Even with all the positive news, many economists are still concerned that a new recession may be on its way or that Federal Reserve's efforts to curb inflation will lead to one.

Karen Dynan is a former Treasury official and Harvard economist. She said that the data was reassuring. The things we are worried about are the things we do not have much hard data on.

The banks are the first to be mentioned. Most of the data is older than the collapse of Silicon Valley Bank, and the subsequent upheaval of the banking system. There are already signs that lenders, both small and large, are tightening their credit criteria in response to this crisis. This could lead to businesses who are their clients cutting back on investment and hiring. It will be months before the full extent of the effects on the economy is known, but many economists -- including those at the Fed -- believe that the turmoil makes a recession more probable.

Although the Fed started raising interest rates over a year ago the effects are only now beginning to be felt in various parts of the economy. The construction industry began to lose jobs only in March, despite the fact that the housing market had been in a slump for most of last year. Manufacturers were also adding jobs up until recently. Consumers are still figuring out what the higher rates will mean for their ability buy cars, pay off credit card debt and take other forms of loans.

Ian Shepherdson is the chief economist at Pantheon Macroeconomics. He said that economic data which paints a rosy image of the economy are a "look back to an old world, that no longer exists."

Image

Shepherdson believes that the overall job growth will turn negative by the summer as the combined effect of the Fed policies and the bank lending crunch hits the economy. This will lead to job losses. He said that Fed policymakers have done'more than enough' to curb inflation. However, they are likely to increase rates again.

Some economists argue, however, that the Fed is forced to raise rates until inflation has definitively retreated. They say that the recent slowdown of consumer price increases is welcome. However, it's partly due to the fall in energy prices and the rising price of used cars. The underlying inflation measures, which remove such short-term fluctuations, have only slowly declined.

Raghuramrajan, an economist and former governor of India’s central bank, said: 'Inflation has started to fall, but I don't know if the momentum will last if they do not do more.'

The Fed wants to reduce inflation just enough without causing a massive pullback in borrowing or spending, which would lead to widespread job losses and a recession. It is not easy to strike the perfect balance, especially since policymakers are forced to make decisions based on incomplete and preliminary data.

Rajan stated that it would be difficult for them to pinpoint the exact problem. They would like to see more of what is happening.

The consequences of a miss could be severe.

The job market recovery in the United States has been nothing less than remarkable over the last three years. The unemployment rate has dropped to a half-century low, from 15 percent in April of 2020. The employers have now added all 22 million lost jobs during the first weeks of the pandemic and another three million. Workers have a rare opportunity to leverage the intense labor demand. They can either demand a better wage from their employers or look elsewhere.

This strong economic recovery has benefited groups who are often left behind by less dynamic economies. People with disabilities, those with criminal records, and those with no high school diploma have seen an increase in employment. In March, the unemployment rate for Black Americans reached a new low. Pay increases have been highest among lower-paid workers in recent years.

Critics say that if the Fed takes its efforts to combat inflation too far, it could lose all of this progress.

Image

William Spriggs is a Howard University Professor and Chief Economist for the A.F.L. C.I.O. He said, "For this tiny instant, we finally get to see what a Labor Market should do." He said that the workers who are currently benefiting from the current strength of the labor market will also be the ones most affected by a recession.

Spriggs stated, "You should know what you're really risking." He said that with inflation already declining, policymakers have no reason to take this risk.

He said, 'The labor markets are finally getting into their stride.' "Instead of celebrating this incredible set of circumstances, the Fed is hanging over everyone and casting shade and saying that this is actually bad."

Other economists warn that the Fed could also be at risk if it does too little. Businesses and consumers have largely treated inflation as a temporary but serious problem. They could create a self-fulfilling proclamation if they begin to anticipate high inflation rates.

In that case, the Fed could be forced to take more aggressive measures to curb inflation, which may lead to a more severe recession. According to many economists this is what happened during the 1970s and 80s when, under Paul Volcker's leadership, the Fed brought inflation under control, but at the expense of the highest ever unemployment rate.

Jason Furman is a Harvard economist who was formerly the top advisor to Barack Obama. He argued that the real debate wasn't about whether unemployment or inflation were worse. The real debate is not between inflation and unemployment, but rather between a little unemployment now or potentially a lot more later.

Mr. Furman warned that if you delay too long, millions of jobs could be lost.

In recent weeks, there have been encouraging signs that the Fed is succeeding in its delicate task of slowing down the economy just enough without going too far.

The Labor Department's data this month revealed that employers had fewer positions available and workers changed jobs less often, both of which were signs that the market was cooling. The pool of workers available has also grown, as more people are returning to the workforce and immigration has recovered.

In theory, the combination of reduced demand and increased supply should allow for the labor market's equilibrium to be restored without widespread job losses. This appears to be the case: The Fed is concerned that wage growth will contribute to inflation. However, layoffs and joblessness are still low.

Jan Hatzius is the chief economist at Goldman Sachs. He said that recent data on the job market made him more confident about avoiding recession. While this outcome is not certain, Hatzius said it's important to keep the current debate into perspective.

Hatzius stated that 'given the unbelievable downturn we experienced in the economy in 2020, with fears of an even worse outcome, if you manage to return to a reasonable rate of inflation and high employment in, say, three to four years, this would be a good outcome.