Fed up and under-fed at the same time: tightening a labour market that is short of people
The plan was to lay off workers who were already too few, to reduce production that was already lower than the year before, to lower prices that were high because production was short.
The Federal Reserve’s plan at the end of 2022 can be stated in one sentence, and the sentence is the argument against it. The Fed intended to loosen a tight labour market by raising rates until employers laid off workers who were already too few in number, in order to reduce production that was already lower than the year before, in order to bring down prices that were high because production was short. If that made sense to you, this page said, the Fed was your friend. This page kept the case that it did not make sense, and the evidence that the recession the Fed was trying to induce had already arrived.
Where we already were
The Chicago purchasing managers’ index, one of the oldest surveys of business activity in the country, fell in November 2022 to a level it had reached only during recessions in its fifty-five-year history, and usually months into one. The single partial exception was the end of 2000, when the index hit this level a month before the recession was dated to begin. Every other time, the economy was already in the red. Zero Hedge’s summary was that the reading “screams recession”. The Fed, meanwhile, was still projecting positive growth for 2023, as Sven Henrich noted it had projected in 2008, and its stated expectation was a soft landing in which only some people would lose their livelihoods.
The labour market the Fed saw
The Fed’s confidence rested on employment. Unemployment was near a fifty-year low, job openings were high, wages were rising, and the two negative quarters of GDP earlier in the year were dismissed as a mirage on the strength of it. A tight labour market means, in the Fed’s model, that demand is too strong, and the remedy is to weaken demand until workers are laid off and wages stop rising.
The labour market that existed
The thesis argued here since the autumn was that the labour market was tight for a different reason: the labour had gone. Excess deaths through the pandemic ran to over a million in the United States. Early retirements took another two or three million from the workforce. And long Covid, by the estimates being published that month, had left millions more unable to work full-time or at all. CNBC reported an economic-impact estimate of 3.7 trillion dollars, comparable to the Great Recession; a Texas vaccine researcher called it the next public-health disaster in the making. Whether the cause in any individual case was the virus, the response to it, or isolation was irrelevant to the economic point. The workers who had produced things were not there, and the people they had been were still consumers, so demand exceeded a supply that could not be increased by any interest rate.
If that was the shape of it, the Fed’s plan would not work in the way it expected. Raising rates would reduce demand only by first reducing employment further, in a workforce already short, which would reduce production further, which is the wrong direction for prices. The result would be a recession with inflation in it, which is the outcome the “transitory” year had already set up.
The Fed is not your friend
The Fed had run with the accelerator on the floor through the months when inflation’s momentum was building, calling it transitory, and now proposed to do the same with the brake. The people who made that error would keep their positions; the people who lost jobs in the correction would not. The advice offered, next time you stand in the meat aisle, was to close your eyes, click your heels and say “it’s transitory” three times, since those were the words that had got everyone here.
Later note. The Chicago PMI stayed at recession levels for most of 2023 and the recession did not come; services carried the economy while manufacturing contracted. Labour-force participation among prime-age workers recovered to above its pre-pandemic level by 2023, which weakens the thesis for that cohort, while participation among the over-55s never returned, which supports it. Inflation fell without the unemployment the Fed’s own projections had assumed, an outcome the Fed’s model did not predict either.