Ex-Fed visiting scholar Laurence Ball says sustainable inflation requires fewer vacancies than unemployed workers.
The Federal Reserve’s view the jobless rate will rise to 4.4% over the next two years is a step in the right direction but is unlikely to be enough to stem underlying inflationary pressures in the U.S. economy that could require unemployment rising to 7%, former Fed visiting scholar and consultant for the IMF Laurence Ball told MNI.
The Fed last week not only increased borrowing costs by 75 basis points for a third meeting in a row but also projected the unemployment rate will slope upward 0.7ppts from now to 4.4% before staying put for about two years.
"That's a step towards realism, but I would say that is still too low to be a likely path that would bring inflation down to target," said Ball who recently produced a Brookings paper on inflation during the pandemic with IMF cowriters Daniel Leigh and Prachi Mishra. "We have started redoing some of our analysis with a 4.4% unemployment peak, and it makes some difference but it doesn't change the basic conclusion."
"My sense is that they're being very optimistic about a moderate tightening being needed and a mild increase in unemployment and they'll probably need a bigger tightening with a higher funds rate than they predict and more unemployment," Ball said in an interview. "The most likely case is between six and seven, maybe closer to seven" percent unemployment.
U.S. inflation jumped 8.3% in the year to August according to CPI, and 6.3% to July for the Fed’s preferred PCE measure, nearly three times the central bank’s official 2% goal. (See: MNI INTERVIEW: Scant Signs Inflation Pressures Abating - Altig)
"The key thing which is creating sustained inflationary momentum now and that has to be addressed is the tight labor market," he said. "Even if all supply chain problems were to get resolved pretty quickly and prices went back to historically normal levels and stay there, as long as we have 1.9 job openings per unemployed worker we're going to continue to have high inflation."
"So, the real question is whether the labor market is going to become less overheated," said Ball, a research associate at the National Bureau of Economic Research.
Fed Chair Jerome Powell last week said the labor market is "out of balance." Fed Governor Christopher Waller has pointed to the Beveridge Curve, which plots the relationship between job openings and the unemployment rate, and argued the labor market could break historical norms with vacancies declining by a large amount without the economy falling into recession.
"We've never historically had a slowing of the economy that reduced job openings without also raising unemployment and so logically it's hard to believe something would affect one and not the other and maybe that's the key issue," Ball said, suggesting he sees the Beveridge Curve may shift back a "third of the way" to its pre-pandemic position.
"Unfortunately, in our economy what it takes to keep inflation under control is a persistent situation in which there are somewhat fewer jobs than there are workers and somewhat fewer vacancies than unemployed workers," he said. "The number which is kind of average historically and seems consistent with stable inflation is something like 0.7 plus or minus something, but certainly less than one."
BELOW ZERO GROWTH
That means returning to stable inflation could depend on even more hardship than the Fed's most recent projections, Ball said. "That's bad. That's a lot of people losing their jobs...It also would certainly trigger a recession being identified by any reasonable method."
And the FOMC median's view of 1.2% real GDP growth next year is overly optimistic, he said. "We expect well below zero growth if we made adjustments consistent with unemployment substantially higher."