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The Fed says this is going to hurt, but it matters who feels the pain

The dominant message from Wednesday’s Federal Reserve announcements was a simple one: Leaders believe that some meaningful economic pain is needed to drive down inflation, and they are willing to impose it.

Why it matters: The Fed is now forecasting a meaningful rise in unemployment in the coming year as it pushes interest rates to their highest levels since 2007 — meaning it will not just tolerate a recession or near-recession, but use it as proof of success. to see.

  • It’s a contrast to just three months ago, when policymakers stuck to a more optimistic story where inflation resolves itself with just a bump for the economy.
  • “We need to get inflation behind us,” chairman Jerome Powell said at his news conference on Wednesday. “I wish there was a painless way to do that. There isn’t one.’

The big picture: Most importantly for both the economic and political outlook is: Who will feel that pain, and how. Some on the left are already attacking the Fed for throwing workers under the bus in its anti-inflation campaign.

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  • Perhaps most prominently, Senator Elizabeth Warren (D-Mass.) tweeted yesterday that she “warned that Chairman Powell’s Fed would put millions of Americans out of work — and I fear he is already on his way to doing so.”
  • If yesterday’s forecasts turn out to be correct — meaning an unemployment rate of 4.4% by the end of next year, down from a low of 3.5% in July — that would mean an additional 1.5 million Americans are out of work.
  • Hypothetically, unemployment could rise so sharply because of just one weak spot in the economy. But in practice, historical examples of this are scarce. Unemployment only rises so sharply in recessions.

There is no doubt that in this scenario, moderately higher unemployment is in fact a Fed goal, with all the moral and political consequences that this entails. But it is going too far to say that workers bear the full brunt of the war on inflation.

  • Tighter money from the Fed is having its first-order effects through the financial markets, as evidenced by the 21% collapse of the S&P 500 this year.

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  • Indeed, if you believe, as many people do, that the era of zero interest rates and quantitative easing has made the rich richer and increased inequality, then the era of rate hikes and quantitative tightening should have the opposite effect.

There are many channels so the Fed tightening could help curb demand and inflation without people losing their jobs. For example:

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  • A wealthy investor decides they can’t afford a vacation home due to stock market losses.
  • Or a company accepts lower profit margins because it believes it cannot raise prices in a slump.

Reality check: But just because those channels exist doesn’t mean that job losses aren’t the most obvious in how people experience the economy.

It comes down to: The 1.5 million people who may lose their jobs under the Fed’s scenario will experience much more pain than the tens of millions who experience moderately lower balance sheets in their investment portfolios.

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