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Fed splits the difference on labour market pain


The Federal Reserve is inching towards acknowledging how painful its inflation fight is likely to be, but it’s still a lot closer to the optimists than the pessimists.
On a day when it raised interest rates by 0.75 percentage point to a range of 3% to 3.25%, the Fed also released economic projections showing that its median forecast for unemployment is 4.4% by the end of 2023, up from the current 3.7%, meaning more than a million fewer jobs as a result of its campaign. That marked an increase from previous projections in June that showed unemployment peaking around 4.1%, which were widely panned as unrealistic. Yet the numbers still look rosy compared with the labor-market damage that historically accompanies rounds of aggressive monetary policy tightening.
For the Fed, the projections are a balancing act between economics and public relations. The central bank is fighting the worst inflation in four decades, and economic orthodoxy suggests that the overheated labour market is creating upward pressure on wages and consumer prices. As that thinking goes, the only way to break the cycle is to send unemployment higher — a barbaric principle on the face of it that many Americans would deeply object to if they could see through the opacity of the central banking process and its web of economic jargon. Yet for better or worse, there’s virtually no hope that policy makers will concoct a better way of tackling inflation anytime soon.
Among the prominent backers of this orthodoxy are former Treasury Secretary Lawrence Summers and former International Monetary Fund chief economist Olivier Blanchard. Speaking this month on a Goldman Sachs Group Inc podcast, Blanchard said that unemployment probably needs to rise to at least 5% in an optimistic scenario and possibly as high as 6% to 7%. Blanchard, Summers and co-author Alex Domash are far more pessimistic than the median Wall Street economist in a Bloomberg survey, but they argue that they have history on their side. Optimists say that this economic cycle is highly distinct, precipitated by an unprecedented pandemic, and that the Fed’s actions may prompt companies to reduce job openings without necessarily laying off many workers. That, optimists say, would bring down inflation with limited pain.
Enter Fed Chair Jerome Powell, who appears to be trying to meet the doomsayers and Wall Street somewhere in the middle (albeit still more oriented towards the latter).
The Fed’s new median projections for 2023 and 2024 are slightly more pessimistic than the median Wall Street economist, but still far more sanguine than the type of damage that Blanchard and Summers foresee. Of course the rate-setting Federal Open Market Committee (FOMC) has a range of views, with governors and regional Fed presidents submitting unemployment forecasts from 3.7% to 5% by the last quarter of 2023, up from a previous range of 3.2% to 4.5% in the June projections.
Overall, the Fed’s economic projections should never be taken literally. Although the FOMC would never say so outright, its projections are as much about managing expectations as they are reflections of where it sees the economy going. But at face value, they signal a move away from full-scale wishful thinking toward plausibility, and that’s at least a positive development toward leveling with the American people.


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