Hiltzik: Should we raise unemployment to fight inflation?

If economic history teaches us anything, it’s that when times get tough, working men and women have goals on their backs.

Current events give us a perfect illustration. The US is at or near full employment with unemployment at an all-time low of 3.6%, but inflation is picking up. So the argument that the remedy for higher prices is higher unemployment is being heard more and more.

The most refined iteration of this argument comes from former Treasury Secretary Lawrence Summers, who put it this way in a June 20 speech in London, as Bloomberg reports:

Labor costs are falling – not rising – price pressures.

– Josh Bivens, Economic Policy Institute

“We need 5 years of unemployment above 5% to contain inflation – in other words, we need 2 years of 7.5% unemployment or 5 years of 6% unemployment or one year of unemployment rate. 10% unemployment”.

Summers calls these “surprising numbers from the Fed’s perspective,” which is that tools in the Fed’s arsenal like short-term rate hikes can be enough to create a “landing.” soft” for the economy – a reduce inflation without causing a recession.

Turning Summers’ statistics into hard numbers is a little tricky, because the unemployment rate doesn’t just measure the number of unemployed. The 3.6% unemployment rate in May was the lowest since the late 1960s.

But in June 2013, the last month before the pandemic when the unemployment rate was 7.5%, about 11.8 million Americans were unemployed, 5.8 million more than the previous month, according to the Bureau of Labor Statistics. motion. About 144 million were active, compared with 158.4 million the previous month.

So Summers is talking about 5.8 million to 15 million Americans being unemployed to bring down inflation.

Summers’ words have been widely cited not only because of his position as Obama’s former appointee, but because he warned that the Biden administration’s initial fiscal policies would stimulate prefer higher inflation.

It seemed like he was predictable, it felt, so maybe he was correct now. (Whether Summers is right or wrong or perhaps right for the wrong reasons is a topic of debate in economist community.)

However, there are significant flaws in equating higher employment with higher inflation.

Summers himself, in an appearance in May at Northwestern University, warned against overconfident generalizations about the economy.

When asked, “Do we need to get out of the hot labor market altogether to reduce inflation?” He replied, “One of the things I’ve learned over time is that it’s best to think about what’s most likely to happen and what looks likely to happen to you. All absolute claims about these things are foolish.”

Low unemployment correlates with high inflation – and high unemployment with low inflation – but not perfectly.

unemployment inflation

(Created with Datawrapper)

The unemployment rate was stable from 4.7% to 3.9% from 1997 to 2000, while inflation was only 1.6% to 3.4%. In 1974, the unemployment rate rose to 7.2%, but inflation reached 12.3%. In 1978-1980 the unemployment rate spiked from 6% to 7.2%, while inflation soared to 13.3%.

Those were the years of “stagflation,” punctuated by the bitter antidote of 20% higher interest rates given by then-Fed President Paul Volcker.

Over the past decade, when the unemployment rate fell from 9.3% in 2010 to 3.9% in 2018, inflation remained well under control, falling to as low as 0.7% in 2015.

It is true that factors other than employment and wage growth both affect prices in all those periods, but that only underlines the many types of pressures that drive prices higher or lower.

Today’s inflation, when it occurs, is less likely to stem from excessive consumer demand, as it would reflect full employment and its consequent wage pressures, than it does. Supply chain bottlenecks such as shortages of raw materials and goods. In economists’ terms, it’s “cost-push” inflation rather than “demand-pull” inflation.

Indeed, in an economic analysis released Tuesday, Adam Hale Shapiro of the Federal Reserve Bank of San Francisco demonstrated that supply constraints, including “labor shortages, constrain production and shipping delays,” as well as the war in Ukraine, which accounts for more than half of the recent increase in inflation, and higher demand for only about a third.

Labor economists also question that higher wages are leading to inflation, and that a reduction in wages due to higher unemployment makes sense as a policy approach. Wages have traditionally grown about 1% a year faster than consumer prices – a work of improving living standards over time.

Over the last year, however, “nominal wage growth … has lagged far behind inflation,” Josh Bivens, research director at the Labor-Supported Economic Policy Institute, wrote in last month. That means “labour costs are falling – not increasing – price pressures.”

Indeed, the Bureau of Labor Statistics in its most recent report said hourly earnings rose 5.2% for all employees and 6.5% for production and non-supervisory employees, in the year ended. ends in May. Over the same period, the consumer price index increased by 8.6%, of which the largest contribution came from energy costs, including gasoline and fuel oil prices.

“In short, non-wage factors are clearly the main driver of inflation,” Bivens commented. Taking steps to quell inflation by reducing employment would cause unnecessary hardship for millions of people, without showing very much benefit.

Using job loss to manage inflation arose from what economists call the Sacrifice Rate – ostensibly the relationship between unemployment and inflation.


Tight supply is contributing the most to inflation, implying that an increase in unemployment will not help reduce inflation.

(Federal Reserve Board)

According to calculations by former Obama economic adviser Jason Furman, in recent decades the rate has been 6 percentage points – a 6% increase in unemployment in a year tends to reduce inflation by one point. percent, as well as two-year increase of 3%. , Et cetera.

Summers’ calculation of the relationship is somewhat looser, although every bit is as mechanical as one would expect to be an economist’s tool.

Among other problems, it places the entire burden of reducing inflation on unemployment, although inflation is a multi-reality phenomenon. It also treats the relationship between unemployment and inflation as an almost constant constant.

This approach goes back to pre-recession policy, when working men and women were seen as just another economic input and recessions were seen as the panacea needed to maintain financial well-being. of the class of bondholders.

It was an era when the prescription for recession was given by Treasury Secretary Andrew Mellon, one of America’s richest men, as “liquidation of labor, liquidation of stocks, liquidation of agriculture. people, liquidating real estate,” as Herbert Hoover describes Mellon’s argument in his own memoirs.

Mellon said, as Hoover recounts, “it was even a panic [that is, a depression] Absolutely not a bad thing. He said: ‘It takes the rot out of the system. High cost of living and high living costs will come down. People will work harder, live more ethically. Values ​​will be adjusted and enterprising people will pick up wrecks from the less competent. ‘”

(Hoover, for his own credit, was appalled by the “unspeakable amount of suffering” that Mellon’s approach could cause.)

Signs are starting to emerge, if slowly, that the factors that have pushed prices higher since late last year are beginning to abate. Crude oil prices on the New York Mercantile Exchange fell in Thursday trading to below $104 per barrel, down from a March 8 peak of $123.70; Gas prices have begun to track, though not at the same pace.

Housing initiation has declined and wage increases have been adjusted. Retailers have reported slower sales and some, stuck with excess inventory, have signaled that generous discounts are in vogue.

Federal Reserve Chairman Jerome Powell, who has become the face of the Fed’s aggressive policy of raising interest rates to cool the economy, hinted that the second sharpest rate hike by three quarters of a point percent may or may not be needed next month. .

That view is echoed by Patrick Harker, president of the Federal Reserve Bank of Philadelphia, who said on Wednesday that regulatory signs could warrant a smaller rate hike in July and conditions will guide Fed policies in September and then even worse. .

“Let’s see how the data plays out over the next few weeks,” Harker told Yahoo Finance.

In short, history advises caution in applying inflationary remedies. The limited tools available to the Federal Reserve are particularly weak when prices are driven by external factors in today’s workplace.

“Inflation is like a disease,” Senator Elizabeth Warren (D-Mass.) told Powell during his appearance Wednesday before the Senate Banking Committee, “and drugs need to be regulated for relevant to the particular problem.”

Under questioning from Warren, Powell conceded that a rate hike by the Fed won’t bring down gasoline or food prices. However, as Warren has observed, “raising rates makes it more likely that companies will lay off people and cut hours to reduce payroll costs.”

That doesn’t necessarily mean that the Fed should judiciously use the powers it has been granted to combat inflation. But that means putting the livelihoods of working men and women at risk, as if they were the ones responsible for inflation, is exactly the wrong approach.

https://www.latimes.com/business/story/2022-06-23/column-do-we-need-to-raise-unemployment-no-we-need-to-protect-jobs Hiltzik: Should we raise unemployment to fight inflation?

Edmund DeMarche

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