Announcing another big rate hike on Wednesday, Federal Reserve Chairman Jay Powell grimly admitted the obvious: “A slowdown in inflation is likely to require a sustained period of below-trend growth, and it will very likely lead to some moderation.” of the labor market come conditions.”
The Federal Open Market Committee now forecasts that the headline unemployment rate will reach 4.4 percent next year, up from previous forecasts of 3.9 percent and the current level of 3.7 percent.
That’s bad news for a White House facing a difficult midterm election despite voter fury over the cost of living increase. But the question, perhaps even more pressing for policymakers and Fed economists, is how exactly that pain might be shared across income brackets.
In recent years, Powell has often defended the Fed’s loose policies, arguing that by ensuring a red-hot economy, the Fed is also creating jobs that lift people out of poverty. Will this momentum now reverse as interest rates rise? In other words, could the Fed’s decision be retrograde?
Judging by some notable new research released this week just before the Fed’s move, the unwelcome answer is “Probably yes.”
This analysis comes from economists Emmanuel Saez, Thomas Blanchet and Gabriel Zucman. The starting point is the observation that it has so far been very difficult to assess in a timely manner how inequality tendencies shape economic growth.
The US government releases aggregate statistics on revenue, expenditure and growth with a delay of just a few weeks. But granular information about trends in different socioeconomic groups is lagging behind – and from different sources. In the past, economists like Thomas Piketty (or even Saez himself) have warned of rising inequality in America by creating historical data series rather than examining current trends.
This time, however, Saez’s group has attempted to fill this information gap by creating so-called high-frequency inequality data. This means bringing together a variety of public and private sources of information, including non-traditional ones, to produce near real-time monthly calculations of trends in income and wealth patterns.
This ambitious endeavor is still a work in progress, and the methodology has been made open source to allow for extensive testing. But the first set of data, dating back to 1976, contains two very thought-provoking messages for America’s current political economy.
First, the recession triggered by the Covid-19 pandemic has had a different impact on US budgets than the global financial crisis. The post-crisis recession triggered a slump in American incomes, and it took four long years for economic activity, as measured by average gross domestic product per capita, to recover to pre-crisis levels.
This post-crisis period was even worse for the poor. According to Saez, Blanchet and Zucman, “It took almost 10 years for the bottom 50 percent [of workers] recover [their] Pre-crisis income levels before taxes”. This is almost certainly one of the factors that have fueled the rising tide of populism in recent years.
However, when the Covid recession hit in spring 2020 and initially caused another sharp drop in income, there was a rapid recovery. “All income brackets have regained their pre-crisis factor income levels within 20 months,” they observe. In fact, by 2021, average real disposable income was a remarkable 10 percent higher than 2019 levels.
And what is even more striking is that the poorest cohorts were not excluded from the gains this time, on the contrary, the average disposable income of the bottom 50 percent was even 20 percent higher in 2021 than in 2019.
This leads to a second important point: while the Covid recovery did reduce income inequality slightly, it was not universal. Racial inequalities remained strong, and inequalities in wealth versus income widened as the Fed’s ultra-loose monetary policy drove up the price of assets held by the wealthy.
But if you look only at real household incomes – arguably the measure most voters are familiar with on a day-to-day basis – the pattern resulted in relative gains for the poor. And that was a “trend break”. [of rising inequality] predominant since the early 1980s”.
Why? Originally, the recovery was due to one-off Covid social payments. The larger and more enduring factor, however, has been strong employment and wage growth among low-wage workers. And in 2022, that tight labor market continues to benefit the poor — even after welfare payments have stopped — whose incomes are 10 percent higher than before the pandemic.
Will this trend now reverse? It hasn’t happened yet. But some progressive politicians, like Democratic Senator Elizabeth Warren, are clearly concerned as interest rates continue to rise, especially given that high inflation tends to hit the poor relatively harder. “What [Powell] Calling “some pain” means putting people out of work, closing small businesses,” she noted last month, fuming at the Fed.
And as the midterms unfold, such attacks could multiply. So all eyes are on Powell’s next move and how this impending “pain” is affecting voter sentiment.