On today’s show we are talking about why interest rates will continue to rise until more people lose their jobs.
It sounds strange to say this, but the Fed wants to see people lose their jobs. On today’s show I’m going to describe why that is. On yesterday’s show we reviewed a new book written by Ben Bernanke, former chairman of the Federal Reserve.
It was only after reading that book that I fully understood the comments being made by current Fed chairman Jerome Powell. There are two mandates at the Federal Reserve.
1) Help the economy achieve full employment
2) Maintain stability in financial markets including price stability.
The second mandate really means managing inflation. It’s no secret that we are experiencing a global inflation phenomenon. This is not limited to the US.
But the theory is that when inflation becomes entrenched, then the expectation of inflation becomes much more difficult to overcome. The result is a wage and price spiral. We are now seeing employees demanding cost of living adjustments to cope with inflation. These adjustments were not happening on a large scale in 2021, but we are seeing both individual and collective agreements where employees are seeing wage gains in excess of 10%.
The theory goes back to the inflationary period of the 1970’s and 1980’s. In those days the expectation of inflation became entrenched in society and a wage and price spiral took hold. Prices increased and employees demanded higher pay in order to keep up. Higher wages would translate into higher expenses which drove higher prices in an endless cycle.
Unemployment is currently running at 3.6%. This is the lowest unemployment since the 1950’s. Unemployment below 4% is considered to be full employment.
So the economists at the Fed know that until unemployment jumps to maybe 5-6% we will continue to see an upward spiral on both wage and price growth.
The current chair of the Federal Reserve must be very guarded in their language. Their words have the power to influence the market in both the short term and the long term. But a past Federal Reserve Chairman is not bound by the same constraints. In my view, after reading Ben Bernanke’s book, I believe I understand the relationships that are at the core of the economic models they are using the to explain how our economy functions.
The Fed’s dual mandate is to deliver full employment, and to manage price stability. They must have both, not just one and not the other. If they have to sacrifice one of those two metrics temporarily in order to get both, I’m convinced that they will allow unemployment to rise in order to stop inflation.
——————–
Host: Victor Menasce
email: podcast@victorjm.com
