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Is the cure for inflation worse than the disease?

Higher prices are painful. A recession could be worse.

A woman shops for chicken at a supermarket in Santa Monica, California, on September 13.
Apu Gomes/AFP via Getty Images
Rachel M. Cohen has been covering social policy and politics for over a decade in Washington D.C. She is a senior domestic policy reporter at Vox.

The last year of inflation has disproportionately hurt low-income and nonwhite families — those with the least flexibility in their monthly budgets to absorb higher prices.

Now those same groups could be hurt by economic policymakers’ plan to tackle inflation through interest rate hikes, and in potentially longer-lasting ways.

Last month, leaders at the Federal Reserve predicted that, given their plans to continue raising rates, unemployment would rise from 3.7 percent (or 6 million people) to 4.4 percent by the end of 2023. In plain terms, this means an additional 1.2 million people would lose their jobs over the 15-month period. “I wish there was a painless way to do that,” Federal Reserve Chair Jay Powell had said. “There isn’t.”

Other financial analysts projected even higher unemployment to result. Bank of America predicted unemployment would reach 5.6 percent by the end of 2023, translating to 3.2 million more people out of their jobs. Researchers at the International Monetary Fund (IMF) said in September that unemployment may need to reach as high as 7.5 percent to curb inflation, which would mean roughly 6 million people losing work.

The Federal Reserve raises interest rates to slow down consumption across the economy: As the cost of borrowing rises, the hope is that people buy fewer things, and prices stop spiraling higher. The latest data shows inflation still up roughly 8 percent compared to a year ago, and recent reporting in the New York Times suggests Fed leaders may even raise rates more aggressively into 2023 than they had previously envisioned. The question is whether the Federal Reserve will be able to hit the brakes when they decide they’ve done enough — or whether it will be too late, and the economy will be hurtling downhill toward a recession that the Fed created but can’t control.

“One thing that’s a very open debate and a very important subtext to all the fights is the question of whether the Fed can actually increase unemployment just a little,” said Mike Konczal, the director of Macroeconomic Analysis at the Roosevelt Institute, a left-leaning think tank. “And with every million who lose their jobs, it’s that much harder to reintegrate them [into the labor force] later on.”

Stabilizing the economy, Konczal said, is like mending a garment. “You can pull at the threads, but if it tears you can’t just push it all back,” he said. “That’s certainly what keeps me very nervous, that the Fed is so worried it underreacted last year [to inflation] that now it might overreact.”

Some economic experts and journalists are asking if the current pain of inflation outweighs the suffering of a potential recession, and if there are less blunt tools the federal government could be leveraging instead.

“To have a smaller paycheck due to inflation, is that really worse than having no paycheck at all?” Today, Explained host Noel King asked Minneapolis Fed President Neel Kashkari last week. “There’s not an easy answer,” Kashkari acknowledged, ultimately arguing that unemployment affects fewer people than inflation, and it’s easier for the government to target assistance to those who might be hurt.

But higher unemployment and recessions don’t just affect those who lose their jobs, and the assumption that the government would be willing or even able to provide targeted assistance to those pushed out of the labor market beyond the maximum six months of traditional (and relatively meager) unemployment benefits seems highly uncertain, given how Democrats’ more generous pandemic stimulus policies have been blamed for contributing to inflation in the first place. Experts say the country still lacks the infrastructure to deliver more targeted aid, and with Democrats barely even mounting a defense of their pandemic assistance, whether there’s political oxygen — let alone technological capacity — to help those in a recession remains unclear.

On top of all this, if rate hikes do push millions more people out of work, those who would likely bear the biggest brunt of that job loss and take the longest to recover are the same groups suffering most now from inflation: low-income workers, workers with less education, and people of color.

Missing a “soft landing” means millions more people could lose their jobs

The workers who are most vulnerable to near-term layoffs work in construction and mortgage lending, and sell products like TVs and cars. These are so-called “interest-sensitive” industries, particularly responsive to changes in interest rates and borrowing costs. The next hit would be those working in firms that are particularly exposed to financial speculation — like traders and tech companies built around equity valuation.

The Federal Reserve’s goal is to achieve a so-called “soft landing” — meaning they want to lower inflation without throwing the economy into a recession.

Earlier this year Powell, the Fed chair, explained their goal was to make it harder for people to switch jobs, since job-switching and the fierce competition to hire workers were driving up wages. In this scenario, maybe a business eyeing higher interest rates would post fewer new jobs or decide not to fill vacant roles. Maybe an employee would see the hiring landscape as less friendly and decide to stay put. “The idea is there’s a whole lot of activity happening that we don’t see by just looking at the unemployment rate,” said Konczal, of the Roosevelt Institute. “So in this scenario, where it becomes harder to switch to new jobs, the economy still cools without unemployment going up.”

Konczal says there’s some evidence that Powell’s “soft landing” argument has been bearing out over the past two months — the number of new job openings has slowed, as have the number of workers voluntarily switching to take another job. Wage data expected at the end of October should provide a clearer picture of where things stand.

But many experts are pessimistic that inflation can really come down without driving up unemployment, and say that if the Federal Reserve wants to see a genuine drop in prices it will have to force layoffs in less “interest-sensitive” industries, even if that increases the risk of a recession. Fewer people simply work in interest-sensitive fields like manufacturing than they did decades ago.

“That’s where face-to-face services like hospitality start to take the hit,” said Josh Bivens, the research director at the left-leaning Economic Policy Institute. “Recessions can have big multiplier effects. Layoffs typically start in construction and then radiate onward, and things can get pretty bad if you have a big spiral.”

It’s harder for less educated, low-income, and nonwhite people to find work after layoffs

While some policymakers are trying to figure out if they could reduce inflation while keeping unemployment around 4 or 5 percent, other economists are sounding the alarm on what even this optimistic aggregate figure obscures — the unemployment rate for Black people is generally double that of white people, and for Hispanic people it’s typically 1.5 times the rate.

In one recent study, researchers found that lowering interest rates disproportionately helped the employment prospects for Black workers, women, and those without a high school diploma. It makes sense — if employers are facing increased competition for labor, they may be less likely to discriminate in the hiring process. Relatedly, over the past year, workers with criminal records and workers with disabilities were more in demand than they have been, as employers struggled to fill vacancies.

“It’s just a truism that when bad things happen in an economy, it’s the marginalized people, the people with less power, who are hurt fastest and most,” said Wendy Edelberg, the director of the Hamilton Project, an economics division within the Brookings Institution. “That should be fiscal policymakers’ laser focus, at all times but particularly in a downturn.”

The government is less likely to offer aid to workers who lose their jobs

When the pandemic hit, and millions lost their jobs or had their working hours reduced, the federal government responded with an array of financial policies to ease the pain such as expanded unemployment benefits, three rounds of stimulus checks, rental assistance, monthly cash deposits for parents with kids, hundreds of billions for state and local governments, and subsidies for businesses — big and small.

The investments kept millions out of poverty and evictions below historic averages, and are credited generally with helping the economy rebound much faster than following past downturns, and more quickly than other nations that had less robust stimulus policies.

But now Republicans have latched onto that federal aid as one of the top reasons inflation is at its highest point in four decades. They blame the Biden administration for putting too much money in people’s pockets, allowing them to spend too much and drive up prices. Some argue the American Rescue Plan was simply too big, or not targeted enough to those who really needed help. Economists disagree over how much the pandemic policies are to blame but Democrats, notably, are not touting their investments on the campaign trail, as voters cite inflation as a top election concern.

Republicans are expected to win control of the House, and Republican Leader Kevin McCarthy has for months attacked Democrats’ Covid policies for driving inflation. This raises the question: If the economy does spiral and workers lose their jobs or their workable hours, what kind of assistance might they expect to receive in that scenario?

“It’s one of the reasons I’m so worried about the Fed potentially overshooting, that we just won’t do that much to help people since we’re told that helping people too generously is what got us into this mess,” said Bivens of the Economic Policy Institute. “I think that’s wrong, but I’m still totally worried about this dynamic.” Bivens also warned that if Republicans control Congress, it might be in their interest to prolong economic hardship ahead of the next presidential election.

“If the Fed slips the economy into recession, what kinds of tools and political capital will be available? That’s a real concern that we aren’t talking about and aren’t being honest with ourselves,” said Mark Paul, an economist at Rutgers who has argued raising rates is the wrong response to the inflation crisis. “In the pandemic, policymakers reacted in a far better way than they have in our lifetime, where, rather than the economy taking 10 years to get to pre-Covid levels, it essentially took 1.5 years. The narrative now is that the government overshot, but the question is what were the other options and what would those have led to?”

Edelberg of the Hamilton Project said if there is a downturn, she hopes we can get “targeted relief” to those most in crisis, so that it only has modest effects on inflation. “We should do that with eyes wide open — knowing it will boost aggregate demand a little bit and that will be okay because a policy should have more than one objective,” she said.

Edelberg acknowledged the country isn’t exactly positioned to distribute targeted relief — the nation’s unemployment insurance system remains in need of serious upgrades. “We should be improving the system so we can find the people who need to get the money, so we don’t need to do things like send checks to everyone,” she said. “We do not have that infrastructure now because we haven’t really valued it.”

Slow wage growth affects even those who keep their jobs

It took 10 years after the Great Recession for wages to finally start rising, long after unemployment had gone back down. Part of this was fueled by state and local minimum wage increases, but part of it, experts believe, was due to a finally tightening economy.

Workers have enjoyed increased power over the past two years amid the even tighter post-pandemic labor market. Wages have gone up, especially for workers at the lower end of the income spectrum, and especially among those who switched their jobs. In 2021, wages grew by 4.5 percent on average, the fastest rate in almost four decades.

Now that we’re finally seeing broad-based gains in the economy, progressive economists warn that aggressive Fed policy could make those raises disappear. One major risk of a recession is slowed wage growth, which can impact everyone, not just those who lose their jobs. Even modest economic downturns can significantly reduce the chance of employers handing out raises. The Federal Reserve has been explicit that its goal is to reach 2 percent inflation — meaning prices would continue to rise in that scenario, just hopefully more slowly and predictably. But if wages are not also rising, then families will still feel worse off and struggle to afford basic necessities.

“This wage growth angle is, by far, the most important reason why just looking at the rise of unemployment in a recession is a radical understatement of how many workers are adversely affected by recessions,” Bivens wrote in July.

One big fear for inflation watchers is the risk of a so-called “wage spiral” — a scenario where wage increases cause price increases, which in turn cause more wage increases. The concern isn’t baseless; wage spirals have happened before, most notably in the US in the 1970s, but it’s certainly not an inevitability. The labor movement was also much stronger four decades ago — over a third were unionized compared to 6 percent of private sector workers today — giving workers the kind of bargaining power they simply lack now.

Fears of a wage spiral have been dissipating somewhat. Wage growth is still higher than pre-Covid levels but has been slowing down this year. Earlier this month, researchers with the IMF concluded that wage spiral risks “appear contained” for now.

What else could be done?

Some economists and writers have warned that raising interest rates further is unlikely to curb some of the root causes of inflation — such as the war in Ukraine and factory shutdowns — and that inflation would come down next year regardless as supply chains get back on track.

Others say more attention should be on things like investigating corporations for raising their prices far beyond the cost increases for raw materials. The House Subcommittee on Economic and Consumer Policy held a hearing on these concerns in late September, and three Democratic lawmakers introduced a bill in May that would seek to ban price gouging during market disruptions. Dean Baker, an economist at the Center for Economic and Policy Research, pointed to what he called “an extraordinary increase in profit shares in a relatively short period” — rising from 23.9 percent in 2019 to 26 percent in the second quarter of this year.

Some centrist and conservative analysts have framed higher unemployment and a possible recession as simply a necessary if regrettable stage in the life cycle of an economy, almost like a biological reset. “The Fed’s rate hikes will hurt,” said the right-leaning Washington Post editorial board. “That’s unavoidable.”

But “the idea that severe recessions are necessary is absolutely not true,” said Konczal. “That’s the whole point of having a Federal Reserve and macroeconomics. And the idea that recessions are somehow regenerative and healing to the economy is also wrong.”

Whether one needs higher-than-expected unemployment or lower-than-existing GDP to bring down inflation is not really clear. “People are not sure if that’s true,” said Konczal. “It’s a small sample size, and we have only so many economies that you can test.”

Others have argued that fiscal policy — as opposed to the Federal Reserve’s monetary policy — demands more attention to combat inflation. (Fiscal policy refers to a government’s decision to tax and spend, whereas monetary policy is about a central bank’s control over the flow of money and credit.) Fiscal policy can be more targeted, but it can also be difficult to pass through the legislative process, and take far longer to have an economic effect.

For example, Rep. Ro Khanna (D-CA) has called for a “production agenda” that would involve new investments in child care, housing, and community college to bring down prices and train Americans to work. These strategies, if successful, would take years however to trickle out. Sen. Elizabeth Warren (D-MA) similarly argued this past summer that Congress investing in child care would help bring more parents into the workforce, which could counteract inflation, though pouring more money into child care amid a worker shortage, conversely, could also worsen it. In August, Rep. Jamaal Bowman (D-NY) introduced a bill that would place price controls on utilities, food, and housing, bolster the scope of the White House supply chain disruption task force, and authorize better data collection on corporate profiteering. (Price controls are controversial, and led to soaring prices after they were lifted in the 1970s.)

Paul, the Rutgers economist, helped advise Bowman on his bill and told Vox that he believes the Federal Reserve is not taking seriously its dual congressional mandate for both price stability and maximum employment. “Right now the Fed seems to be focused on price stability at all costs,” Paul said. “Full employment be damned.”