Recent economic data provide overwhelming justification, if any, for the Federal Reserve to continue or even accelerate its plans to tighten monetary policy. US inflation, as measured by the consumer price index, has highest level for 40 years in December, increased to 7 percent from November’s 6.8 percent. This is the fastest rate of rise since the so-called Volcker shock in 1980, when then-Fed chairman Paul Volcker raised interest rates and pushed the US economy into a deep recession to try to bring inflation under control.
Yet, while price data is eye-watering, it is the labor market statistics, published last week, provides a perhaps even stronger justification for stricter monetary policy. Although there are some signs of surveys from manufacturing companies that bottlenecks are easing, cost pressures are becoming more visible in the job market. It runs the risk of creating the kind of self-sustaining inflation, driven by expectations of price increases, that led Volcker to take such drastic measures more than four decades ago.
Although the pace of job growth slowed in December, the labor market still looks tight. Annual wage growth accelerated mainly to 4.7 per cent, not keeping pace with prices but still above the pre-pandemic norm. While employment growth slowed – the US added just 199,000 jobs – it appears to be because businesses struggled to find workers: the unemployment rate fell to 3.9 percent, slightly above the rate in February 2020.
This departure of workers from the labor market means that although inflation and wage data indicate that the US may be very close to what economists refer to as full employment, there are still 3.6 million fewer workers in the US than before the pandemic. Jay Powell, the current Fed chairman, argues that this should not be an obstacle to continued tightening. In testimony during his Senate confirmation hearing this week he said these workers would be best served by a prolonged expansion and a gradual sharpening. If the central bank falls further behind the inflation curve, it will have rate increasess sharp, as Volcker did, provoked a recession.
It is unclear how much the Fed can really do for these workers at the moment. A “high-pressure economy”, as proposed by President Joe Biden and the Fed, is driving wage growth and encouraging workers to look for better options – stop rates, the portion of workers who leave their jobs voluntarily, has risen. If wage growth is sustained, it could indeed start compensating for 40 years or so of stagnation. This means the workers who are gone, however, probably did not do so because there is insufficient demand.
For that reason, more structural reforms will be needed to attract the unemployed back. Some of the workers are absent because the pandemic did not end. School closures and coronavirus-related absences at childcare providers mean parents often still have to stay home. Others may be concerned about infection in face-to-face workplaces or that jobs may disappear again with another spate of infections.
Other problems are deeper. Labor market participation has declined over the past few decades – and much faster than can be explained by “baby boomers” retiring alone. Indeed, the participation rate for American women is now below that of Japanese women, more due to successful reforms by former Japanese Prime Minister Shinzo Abe than the ultra-loose monetary policy in the country. The Fed has done its part to ensure a strong recovery, it is high time that America’s congressional members do their part as well.