The Fed and the Punchbowl

The table below shows the changes in unemployment rates during six expansionary time periods in the US – generally growth periods following recessions between 1975 and 2021.  

I present this information to help us think about the prospects of a rise in inflation in coming months and years. I do this mostly because the Federal Reserve seems to think that inflation is not a worry now. Their main task, it seems, is to keep the economy humming through near-zero interest rates. Many Fed officials are on record as to the fact that even if we observe some recent changes in the inflation rate, they are probably temporary.

My table refers to the idea that a rapidly growing economy that generates reductions in the unemployment rate often results in higher inflation. Once the Fed observes a significant and durable rise in inflation, then they are compelled to remove the punchbowl from the party.

It is important, therefore, to wonder what the unemployment rate is saying about prospects of durable inflation. To that effect I created the below table which shows unemployment rates in six expansionary periods from 1975 to 2021.

In each of those expansionary periods the unemployment rate declined. The declines varied. For example, in 2003, the unemployment rate peaked at 6.3% and subsequently fell to 4.4%. The change in the unemployment rate was 1.9 points. In 1982, the unemployment rate had peaked at 10.8% and then fell to 5.2%. The change in the unemployment rate was -5.6 points. The common factor in all these episodes of economic expansion was a significant, though variable, reduction in the unemployment rate. In all but one of those episodes inflation increased.

Next, consider the last row of the table. It shows that the unemployment rate had risen to almost 15% in 2020. By early 2021 it had fallen by 8.8 points to 6%.

Some remarks. In the 2020 case, unemployment peaked at a very high rate – higher than any of the previous time periods. But it is also true that the unemployment rate quickly fell by 8.8 points – the largest reduction in the table. While the 6.0% rate in 2021 is not the lowest in the table it is considerably lower than the high rates in the table. That lower rate is already capable of generating inflation.

Summarizing. If the Fed thinks current increases in inflation are temporary, or if they think the unemployment rate has not yet gone low enough to start inflation – then they are not looking at the numbers.

They need to quit mumbling around and waiting for a clear sign from above. It is past time to think about anchoring inflation and expectations of future inflation. It is time to take the punchbowl away from the party. 

 

Table. Unemployment Rate During US Expansions

1975  8.8    1979  5.7   Dif -3.1 

Note: Inflation rose

  

1982 10.8    1990 5.2   Dif -5.6

Note: Inflation rose

 

1992 7.8     2000  3.8  Dif -4.0 

Note:  Inflation did not rise

 

2003 6.3     2007  4.4  Dif -1.9

Note: Inflation rose

 

2009 9.9     2020  3.5   Dif -6.4

Note: Inflation rose

 

2020  14.8   2021  6.0   Dif -8.8

Inflation?