By Michael L. Lahr, Rutgers Economic Advisory Service (R/ECON™)
It’s a tough time to be Jerome Powell. The Federal Reserve Board’s two primary responsibilities are to assure price stability and growth within the U.S. economy, and Jerome Powell is its Chair.[i] As we are painfully aware, prices have been less than stable; the U.S. Consumer Price Index, a key inflation gauge, rose 8.3% year over year in August[ii] — well over the Fed’s preferred target of 2%.[iii] And Wall Street hasn’t behaved well either: The S&P 500 index has dipped by more than 17% since the start of 2022.[iv] Moreover, a low unemployment rate (3.7%) suggests that labor markets are tight, and some employers are complaining that they can’t find qualified workers to fill job vacancies.[v]
The Fed only has two rather blunt tools at its disposal to cope with its responsibilities, and they are inextricably intertwined. The Federal Reserve manipulates short-term interest rates via the federal funds rate, through which it sells or purchases securities—so called “open market operations” (OMOs).[vi] In turn, the total value of securities that the Fed sells or buys moderates the amount of loanable funds available to private banks. The Federal Reserve buys securities from banks or securities dealers when it wants to make more loanable funds available. When this happens, the federal funds rate tends to fall. It follows then that the Fed sells securities when it wants to reduce the flow, and it raises the federal funds rate in the process. The Fed’s ability to affect the flow of funds is somewhat limited due to the types of securities that it may purchase or sell—they are treasury bonds, notes, and bills.
The outcome of its September meeting was that the Fed ratcheted up the federal fund rate by 75 basis points (bps or hundredths of a percentage point) to 3.0%-3.25%; the second such rise within three months. So, just how should these interest-rate rises reduce inflation? Well, the idea is that by increasing borrowing costs and limiting available funds for loans, the Fed is discouraging consumer and business spending. The rises are meant to curb spending on big-ticket items like housing, cars, and capital equipment. They are particularly designed to cut backing of riskier investments. In past inflation runs, Fed interest rises have reduced demand for new workers and dampened firms’ other typical reaction, which is to improve wages of their existing work forces.
Labor is a main expense item of nearly every industry; so, raising wages necessarily induces inflation. A problem with increasing the federal funds rate to fight anticipated inflation is that the Fed might needlessly further stoke inflation if labor markets are not as tight as they believe they are and, thus even worse, stifle growth.
This suggests that the Fed must perceive that labor markets are tight—i.e., we are near full employment and wages are rising a pace. At 3.7%, the U.S. unemployment rate is undoubtedly near an all-time low. But are wages overheating? Figures from the Federal Reserve Bank of Atlanta suggest they grew by a hefty 6.7% from August 2021 to August 2022.[vii] Still, Steven Kamin and John Kearns of the American Enterprise Institute “find the answer is no.”[viii] While the American Enterprise Institute is self-admittedly a center-right research institution, their message echoes those of self-proclaimed progressive and left-leaning research institutions.[ix] The net message seems to be that inflation is high worldwide, so it cannot be arising from overheating labor markets, but rather from worldwide “skyrocketing oil and food prices.” Kamin and Kearns admit, however, that the resurgence of U.S. domestic demand in the wake of the worst of the pandemic has tightened U.S. labor markets somewhat, at least as reflected in the share of job vacancies. Still, they find that core inflation, which rose by 6.3 percent (i.e., excluding energy and food prices, which are persistently volatile), has not yet revealed itself to be induced by overly rapid wage rises, even though it appears related to job vacancies in Japan, Australia, New Zealand, the U.S., Canada, and the Eurozone. That is, persistent job vacancies are restricted to selected segments of the labor market, e.g., occupations affiliated with health, data management, and the digital economy.[x] High turnover rates (both high job separation and hire rates, which result in a large number of vacancies), on the other hand, stand out in those segments of the economy heavily affected by the pandemic, e.g., the hospitality sector.[xi]
The upshot of the above is that, at least through August 2022, wage rates do not yet seem to be a main force behind inflation, although they are threatening. Moreover, a sharp decrease in job vacancies might not signal a substantial rise in unemployment.
We will continue our analysis of other factors that may trigger a future recession in Part 2 of our blog.
[i] Board of Governors of the Federal Reserve System. (2020). “Monetary Policy: What Are Its Goals? How Does It Work?” Available online in September 2022 at https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm.
[ii] U.S. Bureau of Labor Statistics. (2022). “Consumer Price Index Summary – August 2022,” Economic News Release, September 13. Available online in September 2022 at https://www.bls.gov/news.release/cpi.nr0.htm.
[iii]Engemann, Kristie M. (2019) “T https://www.bls.gov/news.release/cpi.nr0.htm he Fed’s Inflation Target: Why 2 Percent?.” Open Vault Blog, Federal Reserve Bank of St. Louis, January 19. Available online in September 2022 at https://www.stlouisfed.org/open-vault/2019/january/fed-inflation-target-2-percent.
[iv] Silverblatt, Howard. “U.S. Equities Market Attributes, August 2022,” S&P Dow Jones Indices. Available online in September 2022 at https://www.spglobal.com/spdji/en/commentary/article/us-equities-market-attributes/
[v] Ferguson, Stephanie. (2022). “Understanding America’s Labor Shortage: The Most Impacted Industries,” U.S. Chamber of Commerce. Available online in September 2022 at https://www.uschamber.com/workforce/understanding-americas-labor-shortage-the-most-impacted-industries.
[vi] The content of this paragraph is translated from material in
Board of Governors of the Federal Reserve System. (2020).” Open Market Operations,” Credit and Liquidity Programs and the Balance Sheet. Available online in September 2022 at https://www.federalreserve.gov/monetarypolicy/bst_openmarketops.htm.
[vii] Federal Reserve Bank of Atlanta. (2022). “Wage Growth Tracker,” September 9. Available online in September 2022 at https://www.atlantafed.org/chcs/wage-growth-tracker.
[viii] Kamin, Steven B. & John Kearns. (2022). Tight Product Markets, Not Tight Labor Markets, Are Pushing up Inflation around the World, AEI: American Enterprise Institute for Public Policy Research. United States of America. Ret Available online in September 2022 at https://policycommons.net/artifacts/2674288/tight-product-markets-not-tight-labor-markets-are-pushing-up-inflation-around-the-world/3697375/
[ix] Baker, Dean (2022). “Inflation Fears and Strong Labor Markets,” Intereconomics, 57(4), 267–268, https://doi.org/10.1007/s10272-022-1069-y
Bivens, Josh. (2022). “Wage Growth Has Been Dampening Inflation All Along—and Has Slowed Even More Recently,” Working Economics Blog, Economic Policy Institute, May 12. Available online in September 2022 at https://www.epi.org/blog/wage-growth-has-been-dampening-inflation-all-along-and-has-slowed-even-more-recently/
[x] Hira, Ron. (2022). “Is There Really a STEM Workforce Shortage?” Issues in Science and Technology, 38(4), 31–35
[xi] U.S. Bureau of Labor Statistics. (2022). “Job Openings and Labor Turnover – July 2022,” Economic News Release, August 30. Available online in September 2022 at https://www.bls.gov/news.release/jolts.htm.