A debate over whether the U.S. is in a recession is consuming Washington. But some in the nation’s capital are asking a more complicated question: Does the U.S. need a recession?
Federal Reserve Chair Jerome Powell said last week the central bank isn’t trying to cause a recession by raising interest rates and doesn’t think it needs to as the Fed aggressively moves to get decades-high inflation under control.
Some economists — including former Treasury Secretary Larry Summers — say Powell is being much too optimistic about the Fed’s ability to tame prices without pushing unemployment much higher. The implication: The Fed chief, who has sought to elevate the central bank’s focus on boosting the labor market, may be forced to accept millions of job losses and a significant recession to curb inflation.
“Unless we have a set of very surprising and positive developments,” Summers told HEADLINESFOREVER.COM, “we’re not likely to see the inflation rate come all the way down to [the Fed’s] target without there being some level of meaningful economic distress.” Summers, who was also a top adviser in the Obama White House, has derided earlier Fed forecasts as “delusional.”
The outcome has far-reaching implications for the country, including for countless American families who have benefited from an extraordinarily strong labor market but also grappled with historic price surges that have eaten up pay raises and strained household budgets. It also presents an enormous challenge for Joe Biden’s presidency, since a miscalculation by the Fed could result in a nosediving economy, persistently high inflation, or worse, both.
While the Fed in June saw the unemployment rate hitting 4.1 percent by the end of 2024, some economists say it may need to rise to nearly 6 percent, and stay there for some time, to bring inflation down — an increase that would undoubtedly coincide with a recession.
Diane Swonk, chief economist at KPMG, said it’s not a question anymore of whether the Fed can avoid a recession, but whether it will accept a mild downturn that slowly grinds down inflation, or a bigger one that does the job quickly.
“The Fed’s optimal scenario is that we get there with only a modest increase in unemployment,” Swonk said. “I think within the Fed, there’s some acknowledgment that it may have to be more than that.”
Still, there are already signs the labor market is starting to cool, which could relieve some pressure on the Fed to keep hiking rates as aggressively as it has been. Job openings in July fell to 10.7 million, the lowest level in nine months though still historically high. And average monthly job growth over the previous three months leveled off to 375,000 in June, from 539,000 in the first quarter of the year. The Labor Department will release new data on hiring Friday morning.
More broadly, economic activity has clearly slowed. The government last week said gross domestic product fell in the second quarter, following a decline in the first three months of the year, raising worries about an imminent recession.
Meanwhile, Powell is under pressure from some left-leaning economists and politicians, such as Sen. Elizabeth Warren (D-Mass.), who argue that the Fed’s campaign to jack up interest rates will do little to quell inflation that’s largely driven by supply shocks like the war in Ukraine and Covid lockdowns in China. In a Wall Street Journal op-ed last week, Warren also blasted Summers as a “cheerleader” for higher rates and “someone who has never worried about where his next paycheck will come from.”
Other skeptics say it’s on the Biden administration and Congress to do more to help the Fed bring prices under control and avoid derailing the economy.
“A recession will not help us tackle inflation — a recession will only hurt working families,” said Sen. Sherrod Brown (D-Ohio), the chairman of the Senate Banking Committee. “We need to bring down prices for workers and families, and tackle inflation at its source — that means fighting corporate price gouging and consolidation, expanding our housing supply and investing in our supply chains.”
Democrats are poised to advance legislation soon, negotiated by Senate Majority Leader Chuck Schumer and Sen. Joe Manchin (D-W.Va.), that they say would help ease price pressures by reducing federal budget deficits — though some forecasters estimate the effect on inflation would be small and wouldn’t materialize right away.
Powell says the Fed doesn’t have the luxury of ignoring supply constraints and hoping inflation comes down on its own. And he stressed that policymakers won’t balk at slower growth or a softening labor market as they continue to raise rates.
“Those are things that we expect, and we think that they’re probably necessary … to be able to get inflation back down on the path to 2 percent and ultimately get there,” he said at a press conference last month.
How much pain will it take?
Summers likened the process to an addict going through detox — it’s going to involve some withdrawal symptoms. For now, the Fed still expects those symptoms to be mild, though Powell acknowledges the path to avoiding recession has narrowed.
In June, Fed officials projected that inflation would fall from an estimated 5.2 percent at the end of this year to just above their 2 percent goal by the end of 2024. At the same time, they expected the jobless rate would rise only half a percentage point, to 4.1 percent from 3.6 percent in June.
Part of their optimism reflects a view among officials that a decline in job vacancies could take some heat out of the labor market and help ease price pressures without driving up unemployment much.
As the economy slows, employers typically pull back on hiring and start laying people off. But with so many vacancies relative to the supply of available workers, Fed officials expect that a decline in job openings won’t necessarily correspond to as big of a rise in the jobless rate this time.