- The chances for an ideal economic “soft landing” have faded, and the Fed is now pushing for a “growth recession.”
- The phrase describes a period of below-average growth, rising unemployment, and slowing inflation.
- The slowdown will “bring some pain,” but letting inflation stay high would be worse, Chair Powell said.
In an ideal world, the Federal Reserve has already vanquished pandemic-era inflation while keeping unemployment at historic lows and avoiding a recession.
Hopes for such an outcome are all but entirely dashed, and the Fed has switched to Plan B.
The central bank’s message at its annual conference in Jackson Hole, Wyoming this year was a simple and stark one. In remarks that lasted less than ten minutes, Fed Chair Jerome Powell warned that cooling inflation will “bring some pain” to Americans in the form of layoffs, weaker pay growth, and higher borrowing costs. The side effects are “unfortunate,” but failure to slow price growth and normalize the economy “would mean far greater pain,” the chair added.
The speech laid to rest the idea that the US can enjoy a so-called “soft landing,” in which the Fed can bring inflation back to its 2% target without driving up unemployment. The central bank has been raising interest rates at the fastest pace since the 1980s in an attempt to ease Americans’ demand and slow inflation. Powell clarified in the August 26 speech that additional rate hikes are on the way, further eroding optimism for a soft landing.
In its place is the likelihood of a “growth recession,” a less-than-ideal outlook. The phrase describes a period of slow economic growth and higher unemployment. It’s not quite stagflation, as that scenario requires high inflation as well as the two aforementioned conditions. Yet it’s a brute-force way to stamp out inflation, and Powell’s latest remarks signal it’s what the Fed is turning to after more than a year of faster-than-usual price growth. Americans about to return to the labor market and look for a new job are going to feel the brunt of the pain.
“Reducing inflation is likely to require a sustained period of below-trend growth,” the chair said, adding that there “will very likely be some softening of labor market conditions.”
Jobs will suffer the most in a growth recession
The Fed has targeted the labor market as a key battleground for fighting inflation, and Powell has specifically cited the massive imbalance between labor supply and labor demand. Government data published last week showed the US still touting roughly two job openings for every available worker, a record that underscores just how tight the labor market has become.
“Softening” that pocket of the economy will translate to serious discomfort for many working Americans. Higher interest rates tend to slow companies’ hiring plans as they shift towards protecting profits and cutting costs. Waning demand for workers can lead to smaller pay gains, as firms don’t have to compete as aggressively to hire.
A growth recession could even drive the unemployment rate sharply higher if enough companies lay off workers to bolster their balance sheets. The rate currently sits at 3.7%, just a hair above the five-decade low seen before the pandemic. A swift easing of labor demand could put Americans out of work at a time when firms are no longer hiring at the voracious pace seen throughout the past year.
It’ll be tough to get inflation lower without “triggering a recession” and losing between 5 million and 6 million jobs, Joe Brusuelas, chief economist at consulting firm RSM US, said soon after Powell’s August speech. “That is about as close as one may get to what can charitably be called a soft landing.”
The economies of the mid-1980s and mid-1990s offer some clues as to what growth recessions look like. The former example followed a historic inflation spell that required the Fed — then chaired by Paul Volcker — to raise interest rates to record highs. While that worked to cool price growth, the economy expanded at a below-trend pace. The unemployment rate did not surge higher, but it lingered at elevated levels for several years before resuming its downward trend.
The economic expansion of the mid-90s was similar, featuring easing inflation, below-average growth, and stubbornly high unemployment. The economic expansions that came after both growth recessions were healthy, but still included some scarring from the few years prior.
The latest growth recession is already emerging
Employment data published Friday offered the first sign that the economy is settling into its phase of slow growth and rising unemployment. The economy added 315,000 new jobs in August, barely surpassing the median forecast but slowing significantly from the July increase of 526,000 nonfarm payrolls.
The June and July gains were collectively revised lower by 107,000 jobs. Although job creation remains extraordinarily strong, the August trend hints that the months of above-trend growth are coming to an end.
To be sure, the uptick in the unemployment rate came from an encouraging trend. Labor force participation — which tracks the share of Americans either working or actively seeking work — edged higher to 62.4% from 62.1% last month, signaling more workers came off the labor market’s sidelines. Since the headline unemployment rate only counts participating Americans who aren’t working, the gain in participation drove the measure higher.
Still, the jobs report perfectly matches the kind of economy the Fed aims to usher in. Higher interest rates will curb job creation further, especially as rates rise to levels considered “restrictive” to the overall economy. Easing demand for workers will also slow the pace at which newly participating Americans can find jobs.
The “softening” Powell spoke of just weeks ago is on the horizon, and with it will likely come higher unemployment, cooler inflation, and a period of below-potential growth.