Hiltzik: Should we increase unemployment to fight inflation?

If economic history teaches us anything, it’s that when times are tough, workers have targets painted on their backs.

The news gives us a perfect illustration of this. The United States is at or near full employment with a historically low unemployment rate of 3.6%, but inflation has increased. So the argument that the cure for higher prices is higher unemployment is coming up more and more often.

The most distilled 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 mitigate — not magnify — price pressures.

— Josh Bivens, Economic Policy Institute

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

Summers called the numbers “remarkably discouraging relative to the Fed Reserve’s view” that the tools in the Fed’s arsenal, such as an increase in short-term interest rates, could be enough to organize a “soft landing” of the economy – a reduction in inflation without causing a recession.

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

But in June 2013, the last pre-pandemic month when the unemployment rate was 7.5%, some 11.8 million Americans were out of work, up 5.8 million from last month, according to the Bureau. of Labor Statistics. About 144 million were working, down from 158.4 million last month.

Summers therefore speaks of 5.8 to 15 million Americans reduced to unemployment to bring down inflation.

Summers’ words were widely quoted not only because of his position as a former Obama appointee, but because he warned that fiscal policies early in the Biden administration would trigger higher inflation.

He seems to have been prescient at the time, it’s felt, so maybe he’s right now. (Whether Summers was right or wrong or possibly right for the wrong reasons is a matter of debate in the community of economists.)

Yet there are significant flaws in the explicit equating of higher employment with higher inflation.

Summers himself, in a May appearance at Northwestern University, cautioned against making overconfident generalizations about the economy.

To the question “Should we completely exit the boiling labor market to bring down inflation?” He replied, “One of the things I’ve learned over time is that it’s best to think in terms of what’s most likely and what seems likely to you. All absolute statements about these things are nonsense.

Low unemployment is roughly correlated with high inflation – and high unemployment with low inflation – but imperfectly.

(Created with Datawrapper)

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

Those were the years of “stagflation,” which ended the bitter remedy of interest rates above 20% issued by Fed Chairman Paul Volcker.

Over the past decade, while unemployment fell from 9.3% in 2010 to 3.9% in 2018, inflation remained well contained, falling to 0.7% in 2015.

It is true that factors other than employment and wage gains have affected prices during all these periods, but this only highlights the variety of pressures that drive prices up or down.

Current inflation, as it happens, appears to be stemming less from excessive consumer demand, which would reflect full employment and the resulting upward pressure on wages, than from bottlenecks in the supply chain. supply such as shortages of raw materials and goods. In economist jargon, this is more “cost-driven” inflation than “demand-driven” inflation.

Indeed, in an economic analysis released on Tuesday, Adam Hale Shapiro of the Federal Reserve Bank of San Francisco demonstrated that supply constraints, including “labour shortages, production constraints and production delays ‘shipping’, together with the war in Ukraine, account for more than half of the recent rise in inflation, and rising demand only for about a third.

Labor economists also question the narrative that higher wages cause inflation and therefore that lowering wages through higher unemployment makes sense as political approach. Traditionally, wages have risen about 1% per year faster than consumer prices – this is an artefact of improving living standards over time.

Over the past year, however, “nominal wage growth…has lagged far behind inflation,” Josh Bivens, research director at the Institute for Economic Policy backed by the workforce. This means that “labour costs mitigate – not amplify – price pressures”.

Indeed, the Bureau of Labor Statistics, in its latest report, said hourly earnings increased 5.2% for all employees and 6.5% for production employees and non-supervisors over the course of the year. of the year ended in May. Over the same period, the consumer price index rose 8.6%, with the largest contribution coming from energy costs, including gasoline and heating oil prices.

“In short, non-wage factors are clearly the main drivers of inflation,” Bivens observed. Taking steps to curb inflation by reducing employment would cause unnecessary hardship for millions of people, with little gain to be gained.

Using job losses to manage inflation stems from what economists call the sacrifice ratio – apparently the relationship between unemployment and inflation.


Tighter supplies contribute the most to inflation, implying that rising unemployment will not do much to lower inflation.

(Federal Reserve Board)

According to calculations by former Obama economic adviser Jason Furman, over the past few decades the ratio has been 6 percentage points – a 6% increase in unemployment over one year tends to lower inflation by a single percentage point, as would two years of 3% increases, etc.

Summers’ calculation of the relationship was somewhat looser, though just as mechanistic as one might expect an economist’s tool to be.

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

This approach is reminiscent of pre-depression politics, when working men and women were seen as just another economic input and downturns were seen as a necessary medicine to preserve the financial well-being of the wealth-holding class. ‘obligations.

This was when the prescription for an economic downturn offered by Treasury Secretary Andrew Mellon, one of America’s wealthiest men, was “wind up the jobs, wind up the stocks, wind up the farmers, wind up real estate,” as Herbert Hoover described Mellon’s argument in his own memoir.

Mellon maintained, as Hoover recounted, “that even a panic [that is, a depression] wasn’t entirely a bad thing. He said: “It will take the rot out of the system. The high cost of living and the high life will decrease. People will work harder, live a more moral life. Values ​​will be adjusted and enterprising people will pick up the wreckage of less capable people.

(Hoover, to his credit, was appalled at “the untold amount of suffering” Mellon’s approach could cause.)

Signs are beginning to appear, albeit slowly, that the factors that have been pushing prices higher since late last year are beginning to subside. Crude oil prices on the New York Mercantile Exchange fell during Thursday’s session to below $104 a barrel, down from their peak of $123.70 on March 8; gasoline prices started to follow, but not at the same pace.

Housing starts slipped and wage gains slowed. Retailers have reported slower sales and some, stuck with excess inventory of merchandise, have reported that generous discounts are on the way.

Federal Reserve Chairman Jerome Powell, who has become the face of the Fed’s policy of raising interest rates sharply to cool the economy, has hinted that a second sharp increase in interest rates three-quarters of a percentage point may or may not be needed next month. .

That view was echoed by Patrick Harker, president of the Federal Reserve Bank of Philadelphia, who said on Wednesday that signs of moderation could warrant a smaller interest rate hike in July and that the conditions that will guide policy the Fed in September and beyond are even murkier. .

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

In short, history advises caution in applying remedies to inflation. The limited tools available to the Federal Reserve are particularly weak when prices are determined by the external factors at work today.

“Inflation is like a disease,” Sen. Elizabeth Warren (D-Mass.) told Powell during her Wednesday appearance before the Senate Banking Committee, “and medicine has to be tailored to the specific problem.”

Under Warren’s questioning, Powell acknowledged that raising interest rates from the Fed would do nothing to lower gasoline or food prices. However, as Warren observed, “Rate increases make it more likely that companies will lay off employees and cut work hours to cut payroll costs.”

This does not necessarily mean that the Fed should use the powers granted to it to fight inflation wisely. But that means putting workers’ livelihoods at risk, as if they were responsible for inflation, is exactly the wrong approach.

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