Opinion – Why? Economês in plain English: The Fed takes aim at the job market

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In the presentation he made last Wednesday (30) at the Brookings Institution, in Washington-DC, Jerome Powell, president of the Federal Reserve (Fed, Central Bank of the USA), signaled a smaller increase in the basic interest rate of the USA as a decision of the next meeting of its currency committee on Dec. The expectation that the increase will be only 50 basis points this time, after four consecutive meetings with increases of 75 basis points. From almost zero in March of that year, the basic rate would end the year in the range between 4.25% and 4.5% per annum.

On the other hand, Powell noted that inflation in the US remains high. He mentioned the estimate that, in the 12 months up to October, inflation in personal consumer spending was at 6% per year. Interest rates will have to reach restrictive levels enough to bring inflation down to 2% a year. He mentioned that there is still ground to be covered by the Fed, assuming that there will be an additional increase in interest rates in 2023.

The monetary tightening is aimed at slowing demand growth relative to aggregate supply, he said, which will require a sustained period of below-trend US economic growth. Despite the monetary tightening and the slower pace of growth this year, we are still not seeing clear progress in curbing inflation.

Powell’s presentation divided the focus between inflation and the job market. The motivation for this was evident when he addressed the three core components of the inflation rate: goods, housing and services other than housing. While the core inflation of goods declined from high levels throughout the year, housing services continued to rise at a rate of 7.1% in the last 12 months. Powell noted, however, the substantial drop in the pace of rise in new rents since the middle of the year.

Powell paid attention to the non-housing services component, the largest of the components, making up more than half of the core price index. It includes education, health services, haircuts, hospitality and so on. He attributed a very large role to this component in projecting the evolution of the core of the index.

As salaries constitute the main cost in these services, it follows the importance of observing the labor market to analyze inflation in this category. According to Powell, at the moment the demand for workers far exceeds the supply of available labor, which has been accompanied by a rise in nominal wages well above what would be consistent with 2% inflation over time. Therefore, a restoration of balance between supply and demand in the labor market would be a relevant item to consider inflation to be contained.

The report on non-farm payrolls – known as the “employment report” – released the Friday after Powell’s presentation corroborated his points about the job market, showing better-than-expected job creation and accelerating growth. wage. Average salary gains registered an annualized increase in the last three months above the one that occurred in the last 12 months.

The unemployment rate remained stable at 3.7%, but the labor force participation rate fell slightly from 62.2% to 62.1%, down from 63.4% in February 2020, before the pandemic. The “great resignation”, as the mass exit of workers from the labor market during the pandemic became known, has not been largely reversed.

At the Brookings presentation, Powell mentioned a “shortfall” of about 3.5 million people in the workforce compared to pre-pandemic trends. More than 2 million of those absent would correspond to an “excess of pensions” in relation to what could be expected from an aging population.

Among the reasons for this, in addition to greater concern for health by older people and difficulties in adapting to changes in the work environment, he cited gains in stock markets and property values ​​in the first two years of the pandemic as factors in the increase in wealth and facilitating early retirement. Of the remaining one-and-a-half million workers absent from the supply, he cited rising deaths from the pandemic and a sharp decline in net immigrant inflows.

He also said that the Fed does not have the tools to increase the workforce, leaving it with instruments that operate on its demand to achieve balance. With the opening of jobs being at a level of 1.7 for each person looking for work, the compression in demand would still be relatively distant.

Powell justified in advance the reduction in the pace of increase in the basic interest rate in December, mentioning the time lag between monetary policy decisions and their effects on the economy, which is quite uncertain, and the fact that the rapid and intense tightening so far this year has yet to is about to be felt. However, he noted that what matters most is how much it has yet to rise and the length of time it is likely to remain tight.

The stakes are split between those who think base interest will go up to 5% or more before a break. If the pause is too early, there is a risk of a future spike in inflation and an even greater tightening afterwards, as occurred in the Volcker era. If it passes the point, the macroeconomic slowdown and the increase in the unemployment rate will be accentuated.

Eyes will evidently also be turned to the financial repercussions of rising interest rates. In this regard, attention is drawn to the fact that longer interest rates –such as those for 10-year Treasury bonds– are far from reflecting the extent of the rise in basic interest rates.

However, judging by Powell’s presentation and fears of price-wage spirals, it is in the labor market that the Fed’s monetary policy script will be written.

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