A recession, if we choose

An obsession with tamping down inflation at any cost will hurt low-wage workers the most.

It's possible for policymakers to embrace the red-hot labor market rather than undermine it.STEFANI REYNOLDS/AFP via Getty Images

You’ve probably noticed that there’s a lot of panic about the economy. This week, the Federal Reserve raised interest rates — again. Global forecasts look grim. And we learned that the United States’ gross domestic product appears to have shrunk for two consecutive quarters, prompting debate over whether a recession has begun or whether everything is not as bad as it may seem.

So let’s filter out the noise for a moment.

How is the economy actually doing? Well, unfortunately, there is no straightforward answer. One thing that’s abundantly clear is that most people don’t feel good about it, and for good reason: Almost everything is more expensive than it was a year ago — and, in some cases, significantly so. In fact, inflation has reached its highest level in over 40 years, which has policymakers scrambling to swiftly tamp it down.

But while inflation is certainly bad, the alternative could be much worse. That’s why the last thing that the Federal Reserve should do is overreact by continuing to raise interest rates.

Now, at first glance, the Fed’s approach might make sense. As loans become costlier, people and businesses are less likely to borrow and spend money, and the rate of price increases would begin to slow down as a result of lower demand. And part of the Federal Reserve’s mandate is to keep prices stable. The problem is, if interest rates are raised high enough, the Fed could trigger a deep and long-lasting recession that would finally give us a simple answer to how the economy is faring: very, very badly.

That’s not a road that anyone should want to go down, but that hasn’t stopped some economists from advocating for it. Former Treasury secretary Larry Summers, for example, suggested that for inflation to be contained, unemployment would need to rise above 5 percent for five years, or about 10 percent for one year. While he later said that he wasn’t pushing for high unemployment as a solution, the implication of his calculation was clear: If the Fed wants to completely control inflation, then it’s going to have to get comfortable with having millions and millions more people out of work. Other economists have similarly pressured the Fed to spike interest rates.

There are several major problems with this policy prescription. The first is that its consequences would fall hardest on the least fortunate. “I think that by focusing solely on inflation, a lot of people are missing the fact that this is a very good economy for low-wage workers,” says Stephen A. Marglin, an economics professor at Harvard.

That’s a counterintuitive suggestion — wouldn’t high prices hit low-income people the hardest? — but it actually holds water: Low-wage workers have seen their incomes rise at a faster pace than practically anyone else. Some of them have even had their wage growth keep up with or outpace inflation. And while many aren’t as lucky, having a job is still better than suddenly losing a source of income.

Of course, that doesn’t mean that inflation isn’t taking a toll or that it should be ignored. “The statistics only get you so far,” Marglin says. “If you’re a person living in rural Maine and you have to drive 40 miles to get to work, you’re in a different situation vis-à-vis high gas prices than if you live in an urban area where you don’t drive that much anyway.” But, he maintains, “if you look at broad statistical groupings, this has been a good economy for the bottom 25 percent, irrespective of inflation.”

This economy has also benefited marginalized groups. Black and Latino unemployment rates, for example, are down to near-record lows. And while they’re still significantly higher than white unemployment rates, that gap has been shrinking. Imposing a recession would likely eliminate any progress that has been made on that front.

It would be wise for policymakers today to follow the advice of a coalition of civil-rights advocates — including A. Philip Randolph, Martin Luther King Jr., Bayard Rustin, and many others — who, in the fall of 1966, released a comprehensive policy proposal titled “A Freedom Budget for All Americans,” which was aimed at eradicating poverty. In it, the advocates wrote, “It would be a monstrous distortion of our values as a nation and a people to argue that we should balance the desirability of reducing unemployment . . . against the prospects of some increases in the price level.”

While that was published well before the high inflation of the 1970s, which, in truth, may have complicated the argument a bit, its core point should still resonate today. As the document continued, “Nothing could be more unjust than to ask unemployed breadwinners or the inhabitants of the slum ghettos to bear the cost of assuring the affluent against some increases in the prices they pay for a third car in the garage, or another fur coat, or even a few more steak dinners a week.”

Dean Baker, a senior economist at the Center for Economic and Policy, a progressive think tank, echoes that sentiment. For a lot of people for whom inflation is a problem, “unemployment doesn’t register on their charts,” Baker says. “That’s, I think, really unfortunate because unemployment for the people experiencing it” — disproportionately those who are at the bottom — “is really horrible.”

So why are some economists advocating for a policy of fighting inflation regardless of the effect on employment levels? For Baker, it boils down to this reality: “The people who are hit by unemployment are, for the most part, not the people writing about economic policy,” he says.

Another problem with dramatically raising interest rates to handle inflation is that it might not even work. “It’s like addressing the problems of the 1970s when we’re really not in the world of the 1970s,” Baker says.

One of the concerns that some economists have had, for example, is that we might be in for a repeat of the wage-price spiral of the 1970s. What that means is that inflation would enter a vicious cycle, with higher prices leading to higher wages, which, in turn, would lead to even higher prices. But with the data that we have today, it doesn’t appear that a wage-price spiral is necessarily in the cards. And that’s because overall wage growth generally has been decelerating. “How do you have a wage-price spiral if wage growth is slowing?” Baker says.

None of this is to say that the Fed should have never started raising interest rates. On the contrary, while inflation has largely been driven by supply shortages caused by the COVID-19 pandemic, pent-up demand, in part stimulated by low interest rates, has also contributed to higher prices, and so targeting spending has likely been helpful. The trick for the central bank is to know when to stop, and it should exercise extreme caution before continuing down this path.

That’s ultimately because this economy is fundamentally different from those in the last century — or even the last two decades. While some similar past experiences, like the 1970s or the World War II economy, may offer some clues, they do not provide a clear roadmap. In the end, this economy is still largely affected by the pandemic, which imposes a lot of uncertainty. The truth is that no one can really predict where it’s going, no matter how hard they try. Who knows what the next wave of COVID infections will look like, and how it might impact supply chains or where people spend their money. And even though some economists, like Summers, may claim that they have been right all along, the reality is that predictions in this economy are a crapshoot. (Summers was right in predicting inflation, for example, but mostly for the wrong reasons.)

That’s why the Fed should keep a steady hand and wait until we get a clearer sense of where the economy is headed before raising interest rates any further. While central banks often like to be proactive in order to stave off the worst, the uncertainty of this economy calls for a more reactive approach from the Fed.

In the meantime, policymakers should embrace the red-hot labor market rather than undermine it, and they should focus on addressing inflation from the supply side — by working to ease bottlenecks in the global supply chains to try to avoid more serious shortages — and through fiscal policy in Congress. In an ideal world, lawmakers would raise taxes on higher earners while improving social programs, like reducing the cost of housing or health care, so that inflation takes less of a toll on poor people. And while Senators Joe Manchin and Kyrsten Sinema have so far shown that they are not all that eager to live in that world, new reports of a potential deal in the Senate, which many economists including Summers support, suggest that may finally change. (It should also be noted that if oil prices continue to fall — something the Fed can’t control anyway — there’s a good chance that overall inflation will start to ease as well.)

And so for now, the Fed in particular should be warned. “I think there’s a real danger of overreacting,” Marglin says, “especially in a world where everybody’s crystal ball is very, very cloudy.”