At the press conference following the Federal Open Market Committee meeting of November 2-3, Federal Reserve Chair Jerome Powell offered a clumsy defense of the current policy stance and left an uncertain view on how things may play out on the inflation front and labor markets. The odds are high that Fed will need to rethink its policy stance in early 2022 and raise official rates sooner than the financial markets expect.
Powell's arguments on labor markets make no sense. For example, Powell implied that September's unemployment rate of 4.8% overstates the tightness in the labor markets as it does not fully capture the shortfall in employment and lower participation rate. Yet, if Powell is correct, more people moving back into the employed workforce as Covid fears subside and bottlenecks disappear would result in a lower jobless rate. (Note: the unemployment rate is the number of unemployed as a percent of the total labor force. So if the labor force increases and the number of unemployed remain unchanged, the jobless rate falls. )
Powell acknowledges that most of the substantial wage increases so far have been for people switching jobs. Yet, that is one of the initial signs of tight labor markets. And, companies react to that development by raising wages for all workers. In the past month, large firms, including Wal-Mart, Amazon, Costco, and Starbucks, to name a few, have announced pay increases for existing staff and additional incentives to stay at these firms in 2022. The worker strike at Deere is also a sign of greater labor activism. It is abundantly clear from wage settlements and worker mobility that labor markets have passed the point of demand and supply balance.
Powell's "transitory" inflation story becomes less credible with each passing day. The Fed now expects supply-driven inflation to persist into 2022, and the solution is faster growth. It is rare, if not unprecedented, for the Fed to argue that more rapid economic growth and the continuation of an easy money policy will result in lower inflation.
Admittedly, an increase in the supply of semiconductors will enable automotive companies to step up the production of new vehicles, and over time dampen the rise in new and used car prices. Yet, higher vehicle production also requires more materials and labor, which are already in short supply. Also, today's inflation story is much broader than what is happening with supply bottlenecks.
As a result, faster economic growth and easy money will not solve the inflation problem. Instead, it would force a rotation, increasing prices in some areas and slowing the advance in others. In other words, Powell's risk management is not only risky; it has a higher chance of failure than success.