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The employment-inflation conundrum
What does the chart show?
This chart shows US year-on-year Consumer Price Inflation (CPI) and the level of US unemployment since 1950. Inflation in the US has recently been at its highest level in around 40 years with the latest data from August putting year-on-year inflation at 8.5%. Alternatively, unemployment in the US has reached as low as 3.6% following a sharp recovery from the record levels of unemployment seen during the Covid-19 pandemic. Inflation and unemployment have always been linked, with periods of high unemployment often coinciding with lower levels of inflation and vice versa.
Until the 1970s this link was seen to be causational with economic expansions driving up prices, encouraging businesses to grow and hire more employees. This idea was disproved in the late 1970s when expansionary fiscal and monetary policy was used to try and bring down high levels of unemployment in the US. However, rising prices and declining confidence instead produced a combination of higher inflation and unemployment that only a federal funds rate as high as 19% and a difficult recessionary period could bring under control.
Why is this important?
The relationship between inflation and unemployment is extremely relevant to the situation facing the US economy today. With the Fed making tackling inflation its number one priority, US jobs data is one indicator as to how effective the Fed’s strategy is proving to be. Although the relationship is not causal, historical data suggests that inflation does not tend to peak until labour markets show signs of loosening. The Fed has a mandate to keep unemployment low, but a tight labour market can lead to a wage-price spiral; which, when combined with global macro events such as supply chain issues and the Ukraine-Russia crisis, has contributed to the persistent levels of inflation.
The Fed faces a tough balancing act between acting too strongly and strangling economic growth, and not acting strongly enough and allowing high inflation to persist. The US labour market has shown some early signs of cooling in response to the Fed’s more hawkish policy but still remains tight. Several similarities can be drawn between the current situation and the stagflationary period of the late 1970s. High oil prices have driven up inflation, and the US now faces a fall in confidence and a stagnation of economic growth. Rising interest rates combined with persistently higher prices may now result in a stagflationary period in the future. In the 1970s, the Fed acted decisively to tackle the issue inflicting a recession in the process. There are some who believe that the Fed must have its own ‘Volcker moment’1 if it wants to effectively deal with the issue.
https://en.wikipedia.org/wiki/Volcker_Rule
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By Mondial DubaiWhat does the chart show?
This chart shows US year-on-year Consumer Price Inflation (CPI) and the level of US unemployment since 1950. Inflation in the US has recently been at its highest level in around 40 years with the latest data from August putting year-on-year inflation at 8.5%. Alternatively, unemployment in the US has reached as low as 3.6% following a sharp recovery from the record levels of unemployment seen during the Covid-19 pandemic. Inflation and unemployment have always been linked, with periods of high unemployment often coinciding with lower levels of inflation and vice versa.
Until the 1970s this link was seen to be causational with economic expansions driving up prices, encouraging businesses to grow and hire more employees. This idea was disproved in the late 1970s when expansionary fiscal and monetary policy was used to try and bring down high levels of unemployment in the US. However, rising prices and declining confidence instead produced a combination of higher inflation and unemployment that only a federal funds rate as high as 19% and a difficult recessionary period could bring under control.
Why is this important?
The relationship between inflation and unemployment is extremely relevant to the situation facing the US economy today. With the Fed making tackling inflation its number one priority, US jobs data is one indicator as to how effective the Fed’s strategy is proving to be. Although the relationship is not causal, historical data suggests that inflation does not tend to peak until labour markets show signs of loosening. The Fed has a mandate to keep unemployment low, but a tight labour market can lead to a wage-price spiral; which, when combined with global macro events such as supply chain issues and the Ukraine-Russia crisis, has contributed to the persistent levels of inflation.
The Fed faces a tough balancing act between acting too strongly and strangling economic growth, and not acting strongly enough and allowing high inflation to persist. The US labour market has shown some early signs of cooling in response to the Fed’s more hawkish policy but still remains tight. Several similarities can be drawn between the current situation and the stagflationary period of the late 1970s. High oil prices have driven up inflation, and the US now faces a fall in confidence and a stagnation of economic growth. Rising interest rates combined with persistently higher prices may now result in a stagflationary period in the future. In the 1970s, the Fed acted decisively to tackle the issue inflicting a recession in the process. There are some who believe that the Fed must have its own ‘Volcker moment’1 if it wants to effectively deal with the issue.
https://en.wikipedia.org/wiki/Volcker_Rule