There is a political debate about whether the US economy is in a recession.
Republicans say that because Gross domestic product, a key economic metric, has been negative for the past two quarters, that’s a recession. Democrats point out, correctly, that job growth is strong and the definition of a recession is not so simple.
But the debate misses an important point: There is a real risk of recession, and whether one happens is largely a decision of the US government. The Federal Reserve is hiking interest rates to quell inflation, and there could be major collateral damage.
“We’re not trying to have a recession,” Federal Reserve Chair Jerome Powell said this week. “And we don’t think we have to.”
Higher rates make money more expensive to borrow, which makes people and businesses spend less. This results in less overall demand for goods and services, which hopefully leads to companies lowering their prices to win over shyer buyers.
A potential side effect of lower consumer spending is millions of people losing their jobs — but Powell doesn’t say it that way.
“If you translate Fed-speak into people-speak it doesn’t sound great,” Claudia Sahm, a senior fellow at the Jain Family Institute and a former Federal Reserve economist, said in an interview with HuffPost.
Sahm praised Powell for communicating more to the public than his predecessors. But Fed-speak is abstract. Powell says inflation is caused by an imbalance of supply and demand, with too much of the latter and not enough of the former. Raising interest rates reduces demand, and that’s how the Fed restores balance. He acknowledges that achieving balance will involve a necessarySoftening of labor market conditions.”
The big question: How much softer should the labor market get?
Powell said that despite the shrinking Gross domestic product, he doesn’t believe the economy is in recession because the labor market is still so strong. The National Bureau of Economic Research, the official recession scorekeeper, says a recession involves “a significant decline in economic activity that is spread across the economy and lasts more than a few months,” with a major impact on Payroll employment.
The national unemployment rate is 3.6%, which is very low by historical standards. Many economists believe that when unemployment is too low, it can cause inflation and that there is a “natural” rate of unemployment that does not cause inflation. If the unemployment gets lower than the natural rate, the theory goes, then inflation goes up because too many people are earning and spending.
Powell suggested at a press conference Wednesday that the natural unemployment rate is probably not 3.6% right now.
“It could be higher,” they said. “And my own instinct is that the natural rate of unemployment is higher.”
Sahm said that Powell is essentially saying the actual unemployment rate needs to be higher. One estimate of the natural rate puts it above 5%. “Going from 3.6 to five? That’s a recession,” Sahm said.
Some economists, Sahm included, are skeptical that there is such a clear link between inflation and unemployment. And many have questioned whether the Fed should squash demand when supply chain problems – such as COVID lockdowns in China – are major reasons for the imbalance of supply and demand.
A Reporter asked Powell on Wednesday what he would say to the workers who might lose their jobs as higher interest rates clamp down on economic activity.
“I guess the first thing I would say to every household is that we know that inflation is too high,” Powell said. “We understand how painful it is. Particularly for people who are living paycheck to paycheck and spend most of that paycheck on necessities, such as food and gas. And heating their homes. And clothing and things like that. We do understand that those people suffer the most.”
As for job loss, Powell went abstract: “As I mentioned, there will be some, in all likelihood, some softening in labor market conditions. We need growth to slow to below-potential growth. We don’t want this to be bigger than it needs to be, but ultimately if you think about the medium and longer term, price stability makes the whole economy work. It’s what can give us a strong labor market and wages that aren’t being eaten up by high inflation.”
Sahm thought Powell’s answer was frustrating.
“Those paycheck-to-paycheck people are going to be the first to lose their jobs,” she said. “I wish they would be a little more straight up about what it’s going to mean.”