Furman says that the US would need an average unemployment rate of about 6.5% in 2023 and 2024.
Evan Vucci/Associated Press
Rising interest rates combat inflation by encouraging companies to cut expenses — often at the cost of jobs.
An economist who served under Obama predicts a 6.5% average unemployment rate to reach desired inflation levels.
That would reverse the current trend in which companies are scrambling to hire workers, not fire them.
Inflation in the US looks like it’s peaked, but we’re not out of the woods yet. The fight to bring down surging price growth could mean a rough two years for job seekers — a hard pivot from the power they’ve enjoyed during the Great Resignation.
That’s according to a new paper from the Brookings Institution, which predicts that a high unemployment rate will be necessary to combat inflation. Inflation is typically inversely tied to unemployment. The rule goes: when unemployment drops, inflation rises, and when unemployment is high, inflation goes down.
Currently, the Federal Reserve predicts the national unemployment rate will reach 4.1% in 2024, but the Brookings team argues that the Fed will need to push it “far higher” in order to bring inflation down to its 2% target, which it wanted for the end of 2024.
“We find that this unemployment path returns inflation to near the Fed’s target only under optimistic assumptions,” the researchers write in the paper. “Under less benign assumptions about these factors, the inflation rate remains well above target unless unemployment rises by more than the Fed projects.”
Because of this outlook, Jason Furman, former chairman of the White House Council of Economic Advisers under President Obama, called this “the scariest economic paper of 2022.”
He wrote in an op-ed for the Wall Street Journal this week that, based on Brookings’ findings, the Fed will need to be aggressive about raising rates even if unemployment continues to rise. Running his own calculations, Furman says that the US would need an average unemployment rate of about 6.5% in 2023 and 2024 to hit its 2% inflation rate target. In August, the unemployment rate was about 3.7%, according to the Bureau of Labor Statistics. And depending on the labor market, he said, or other factors related to supply, “the outlook could be more painful.”
Among a few suggestions for the Fed, Furman says it should lower its expectations for the economy, such as aiming for a 3% inflation rate over a 2% one.
“While fighting inflation should be the central bank’s only focus today, at some point the Fed should reassess the meaning of victory in that struggle,” he said.
Job losses may be necessary to lower inflation
Furman’s 6.5% projection is based on the assumption that, in addition to the Fed’s aggressive fight against inflation, the labor market will also cool slightly on its own, with job openings falling to two-thirds their number from before the pandemic. He also assumes that inflation expectations will revert to where they were pre-COVID, and that the price of gas will continue to fall.
What that 6.5% means is that the next year and a half will feature many layoffs, in addition to continued price hikes and expensive borrowing.
That’s a necessary burden, economists and the Fed say.
“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” Fed Chair Jerome Powell said during August 26 remarks. “But a failure to restore price stability would mean far greater pain.”
That would reverse the trend the labor market has seen during the pandemic, Insider’s Ben Winck reported this month. The most recent data from the Bureau of Labor Statistics shows that job openings still exceed available workers by two-to-one, extending a trend of extreme imbalance in the job market.
In the recent past, Americans have been dealing with high inflation while seeing high wage increases, even if those increases aren’t quite keeping up with inflation for most people. The next challenge will be dealing with the reverse scenario, as companies look to shed employees, rather than hire them.