Right Now, Inflation Matters More than Unemployment
There's more to a job market than job creation. Wage gains now are not impressive — workers see their real incomes falling, and they're mad.
As we saw in a report Tuesday morning, US inflation is at its highest level in 40 years, with the headline consumer price index rising 8.5% from a year earlier. But economist Justin Wolfers notes that US unemployment is likely to soon reach its lowest level 50 years, and he wonders if people will talk about this as much.
This marks an improvement in the liberal discourse about the economy from several months ago, when inflation was waved off too easily as merely transitory. Now we see a sort of “choose your own adventure” commentary on the economy — inflation is really bad, the job situation is really good, and how good you think the economy is depends on how you weigh those two essentially symmetrical factors.
But this is still not quite right, for a few reasons.
First of all, voters who consistently report being distressed about the economy (and inflation in particular) already know this is a good time to find a job. Gallup’s most recent poll on this, from October, found 74% of respondents said it is “a good time to find a quality job” — a record level. The easy availability of jobs today is not a secret.
Second, the unemployment rate is only one metric for evaluating the job market, and it’s currently the most favorable metric. A more holistic view of the job market is less reassuring. Despite two years of rapid job growth, there are still slightly fewer Americans working than there were before the pandemic. This is partly because people left the workforce and are no longer counted as unemployed. This isn’t necessarily a disaster — a lot of those workforce departures were early retirements made possible in part by rising asset prices — but it undercuts how positive we should feel about that low unemployment rate.
Third, rock-bottom unemployment is in part a reflection of certain dysfunctions in the labor market. A labor shortage created purely by strong demand is good economic news, but a labor shortage created by a negative shock to labor supply is not — it reduces the productive capacity of the economy, and that effect has to be felt somewhere. And one reason workers are scarce is that visa issuance remains heavily backlogged; the US has not received the usual influx of immigrants into the labor force. The resulting scramble for workers puts upward pressure on wages, but it’s also a headache for business owners, managers, customers — and even for many workers, who are harried and overworked in understaffed establishments.
Fourth, and perhaps most importantly, that aforementioned upward pressure on wages hasn’t been enough to overcome the upward pressure on prices reflected in that sky-high inflation rate. As Jason Furman notes in The Wall Street Journal, the 5.6% annual rise in nominal wages over the last 12 months — which looks robust on its face — actually means that real wages have declined 2.7%, the fastest rate of decline in 40 years. Real incomes aren’t just falling, they are falling especially fast. Of course people are mad about the economy.
The unfortunate story here is that, while the tight labor market was supposed to do two very good things, it actually only did one of them. The good thing it did was make it easier than usual to find work, especially for people on the margins of society who tend to have the most difficulty finding a job at all. That’s great. But the other thing a lot of people expected — I expected — was that a tight job situation would tend to force wages to rise faster than prices, with workers capturing a larger share of total economic output as income. And that’s not happening; the opposite is happening.
A lower unemployment rate strengthens the bargaining power of workers, enabling them to obtain larger nominal wage gains. That same stronger demand, however, also increases the pricing power of businesses. With so many eager customers, businesses can charge higher prices. Which goes up more — the bargaining power of workers or the pricing power of businesses — is theoretically ambiguous.
The available substantive fixes here are what they have been all along. The Federal Reserve needs to raise interest rates (and is raising interest rates) which will cool inflation, but with some unfortunate side effects. The president should pull what levers he has on trade, immigration, and regulation to reduce inflation. He should pursue an all-of-the-above energy policy that reduces the global importance of Russian hydrocarbon production (something that isn’t possible overnight). And Congress should refrain from adding fiscal stimulus, which would tend to produce lots of inflation and little real economic growth in the current environment.1
The one good piece of news for Democrats is that we might be at the peak for inflation.
Inflation in March was heavily driven by the late-February start of the war in Ukraine, which caused prices to spike for fuel, and also for certain services that rely heavily on fossil fuels, like air travel. But gasoline prices have already moderated significantly since last month. AAA reports the national average gasoline price is $4.098 per gallon of regular unleaded as of April 12. That’s up sharply from $2.863 a year ago, but down from $4.326 a month ago. So April’s inflation number is likely to reflect negative inflation from gasoline prices on a month-over-month basis, and significantly less contribution to annual inflation from gasoline than we saw for March.
Meanwhile, core inflation moderated significantly in March, falling to 4.0%, even as headline inflation rose sharply.
I think people sometimes get a little confused about the importance of core inflation, which excludes food and fuel costs in measuring price changes. What matters to consumers is headline inflation, because it reflects the overall change in their cost of living. In fact, consumers are likely especially cognizant of the change in food and fuel prices because people buy food and fuel so frequently. But because food and fuel are especially vulnerable to supply shocks — like the one caused by the war in Ukraine — they tend to move around in price a lot for reasons that are not necessarily predictive of future price changes. So core inflation trends may tell us more about the likely future track in headline inflation than the recent headline inflation trend itself does.
And core inflation is down because some of the trends that drove inflation over the last two years seem to be finally unwinding. The price of used cars fell in March. In fact, prices for durable goods overall fell in March. It’s fairly likely that — if conditions in global oil markets don’t get worse than they are right now — inflation will generally fall between now and the end of the year. That’s what private sector forecasts say, in addition to the forecast from the Federal Reserve.
All that said, this hopeful story is not that hopeful. Here are a few problems:
Services inflation, which had been modest coming out of the pandemic, is starting to inch up.
High rents and home prices are increasingly flowing through into reported inflation, and these don’t seem to be moderating yet (though higher interest rates may help).
Depending on the trajectory of the war in Ukraine and the related sanctions, oil prices (and therefore gasoline prices) could go up again.
That uncertainty is all the more reason for policymakers in Washington to place inflation-fighting at the top of their agenda. They may be lucky, with more external economic forces breaking their way in the next few months and fewer breaking against them. But they’ll also need to make whatever luck they can.
One difficulty here is that some of the inflation-fighting tools available to policymakers are themselves fiscally stimulative, such as cutting gasoline taxes, or lifting tariffs. These moves would still produce a net reduction in cost of living, partly offset by inflation from the stimulus effect. Ideally, Congress would find offsets to avoid creating a fiscal stimulus, as members tried to do with a deal to fund further COVID relief by clawing back unspent aid dollars previously allocated to states, which are generally in budget surplus after receiving excessive aid allocations from the American Rescue Plan. Alas, the deal to do so was killed by Democratic members who wanted to keep the excess relief funds reserved for their home states.