Why does good news about the economy sound bad to the Fed?

Many analysts and forecasters expect the recession to end next year. Yet month after month, more and more data shows strong, if slow, growth in employment, unemployment and economic growth.

“You don’t have an economic crisis in the US until consumer spending slows, businesses respond with cost-cutting measures and that includes layoffs,” said Stephen Miran, Amberwave co-founder and former Treasury chief. And so far, that hasn’t happened. In fact, unemployment remains at pre-covid levels.

So, if the economic indicators are strong, why is it common wisdom that a recession could happen next year?

It all boils down to inflation and the Federal Reserve’s response to it. The Fed appears to be willing to project significant changes in the labor market — more layoffs, higher unemployment — if it isn’t trying to trigger one. That’s because the Fed’s main goal is to reduce inflation, and its tool to help it do that is to reduce the labor market by raising interest rates.

Despite several reports showing a slowdown in inflation, including one earlier this week that didn’t show a drop in rates last month, the Fed insisted on Wednesday that it would have to act, raising interest rates by another half a percentage point.

“The labor market continues to be sluggish, with demand outpacing the supply of workers,” Fed President Jerome Powell said at a press conference on Wednesday. In other words, the Fed thinks that wages are growing so fast that inflation will drop from about 7 percent – which has been the case for the past year – to close to 2 percent.

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And the effects of the Fed’s rate hikes could soon be felt throughout the economy.

“The Fed is saying that even if they don’t reach a higher rate, there may still be residual effects because of the already tight environment,” said Michael Gapen, chief U.S. economist at Bank of America. former Federal Reserve Economist. “I’m listening to what the Fed is saying; they’re saying we want to shrink the economy now,” Gapen said. “They’re raising rates to shrink the economy and reduce labor market imbalances. Historically when we do this, we have a financial crisis 12, 18 or 24 months later. “

Why does the good news seem bad?

Although parts of the inflation picture are beginning to slow and rebound – and many analysts expect housing prices to slow – the Fed has planned to increase the cost of non-housing services.

Consider, for example, the cost of grocery shopping, which has risen 8.5 percent in the past year, according to the Bureau of Labor Statistics. A major component of this high cost is labor. Restaurant employment has not returned to epidemic levels, meaning that returning workers may demand higher wages. With real wages rising by about 5 percent a year, the Fed sees little chance of inflation falling without further action.

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During the long period between the Great Recession and the covid pandemic, a common complaint was that wages grew slowly. Now, according to the Fed, workers’ wages are rising above inflation. The Fed also said many workers are worse off as inflation erodes their paychecks.

These jobs, Powell said Wednesday, are “labor market dynamics,” meaning that whether they go up or down in value, or how much they go up in value, depends on whether the wages of the workers who provide them rise quickly or slowly.

“There is hope … that inflation is not going to come down that fast, so we have to stay there to raise prices higher to get to where we want to go.” And that’s why we’re recording these high rates and why we expect them to stay high for a while,” Powell said.

According to the economic indicators released on Wednesday by the Fed, the rise in interest rates will continue at the beginning of next year and that unemployment should rise to about 4.6 percent.

“Normal” recession

Bank of America’s Gapen Group estimates that unemployment could rise to 5.5 percent, which it said would remain close to the unemployment rate of previous years and a “slight” recession.

“We haven’t had one of those ‘regular recessions’ in a while,” Gapen said. “‘We don’t want a big recession; we are not looking at the severity of the financial crisis.” Previous recessions were caused by major crises – the financial crisis of 2007-2008 or the arrival of the covid epidemic – while previous businesses have been controlled by the Fed, Gapen explained: “It could be similar to others. another business Decades ago the Fed temporarily put the brakes on the economy due to inflation. ” In this case, the Fed also has the power to revive the economy quickly, by reducing rates. “It doesn’t seem like there are any triggers for a big recession,” said Gapen.

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Worth checking out

A recession, if it is coming, may not happen this year. In order for a recession to fall, there must be significant economic change. This could be caused by a combination of the downturn causing companies to lay off more workers and small businesses to close, Miran said.

“This is a very difficult situation for people and a lot of pain it has caused to the economy and to many families,” Miran explained. This decline in hiring businesses and increased employment can be attributed, Gapen said, to the alcohol shortage.

But right now, Miran said, “The key to believing that we are at risk is that the economy will be severely damaged. In most cases, until now, they have not really spread. You need a lot to reduce the real economy.”

Thanks to Lillian Barkley for editing this article.


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