The Fed should get ready for higher unemployment

ANNOUNCING another interest-rate increase on Wednesday (Jul 27), United States Federal Reserve chair Jerome Powell said that the path toward a soft landing — with lower inflation and no significant rise in unemployment — has narrowed. The question is whether there is any such path.

On Thursday, the first estimate of US second-quarter gross domestic product (GDP) showed a fall of 0.9 per cent at an annual rate. This came after a drop of 1.6 per cent in the first quarter. Two consecutive quarters of lower GDP are generally termed a “technical recession” — although it’s too soon to say whether this one is the real thing. The data get revised and, more important, the labour market still looks exceptionally tight. Under current circumstances, Powell would be delighted with a pause in output growth that causes no rise in unemployment yet still presses down on inflation. That would be deemed a soft landing.

But would this kind of slowdown suffice to get inflation back under control? Monetary policy can curb growth in demand — somewhat uncertainly, and with a lag. How that demand resolves into changes in output, employment and prices is beyond the Fed’s reach. The central bank’s choices boil down to this: Does it try to curb demand gradually (which risks letting high inflation get entrenched) or abruptly (which risks a severe recession and much higher unemployment)? It has no finer control than that.