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Higher interest rates could help, Powell says. Not everyone agrees.

The Federal Reserve has outlined a fix it says can help with surging prices and a tight labor market. Economists say it’s much more complicated.

A hiring sign at a restaurant in Arlington, Va., last month. The U.S. unemployment rate has fallen below 4 percent, but many companies continue to report challenges finding workers. (Stefani Reynolds/AFP/Getty Images)
9 min

There are two troubling forces threatening the economy right now, both consequences of the covid pandemic. Prices are surging to levels not seen in 40 years. And turmoil in the labor market continues to pinch businesses — there just aren’t enough people filling open jobs.

In Nashville, Dependable Delivery is feeling the strain on both ends. The courier service has raised prices and added a fuel surcharge to keep up with the escalating cost of gas and new vehicles. The company’s president, Dave Myers, said the price bumps are key to retaining his staff of nearly 40 full- and part-time drivers, who are in high demand in such a tight labor market.

“It’s barely sustainable,” Myers said. He called the dynamics swirling around his business “a balancing act.”

In recent weeks, policymakers at the Federal Reserve have outlined a fix they say can help address both problems plaguing the economy. In public remarks, Fed Chair Jerome H. Powell and his colleagues argued that a steady series of seven rate hikes this year can not only bring down soaring inflation, but can also help reset the job market by cooling off demand for labor.

Fed officials discuss more aggressive rate hikes to control inflation

Higher interest rates are the Fed’s go-to mechanism for tackling inflation, as they make the cost of borrowing or investing more expensive, and can put a damper on spending by both households and businesses. If companies decide they don’t need as many employees, then the current high demand for workers could also ease up.

An interest rate hike will affect anyone with a home mortgage, car loan, savings account or money in the stock market. (Video: Daron Taylor/The Washington Post)

Powell and other Fed officials hope their plan can balance out the job market and help address a worker shortage that’s become a fraught feature of the recovery. Americans continued to switch jobs at near-record rates in February, with 4.4 million workers leaving their positions, according to recent Bureau of Labor Statistics data. Powell often cites the fact that there are about 1.7 job openings for each person looking for work.

“So that’s a very, very tight labor market, tight to an unhealthy level, I would say,” Powell said last month. “The idea is we’re trying to better align demand and supply, let’s just say in the labor market. … If you were just moving down the number of job openings so that they were more like one to one, you would have less upward pressure on wages. You would have a lot less of a labor shortage.”

Fed raises interest rates modestly, plans seven rate hikes in total this year

Yet the Fed’s plan — cutting inflation, making fewer jobs available — tackles the demand side of the economy. Rate hikes alone can’t increase the supply of workers or assuage peoples’ fears of getting sick from covid. They can’t provide child care for working parents, change immigration policy or entice early retirees — some 2.6 million by some estimates — back into the labor force.

“The Fed’s tools are designed much more around encouraging employers to want to hire than at getting people to want to work,” said Jason Furman, who served as a senior economist in the Obama administration. “I think our labor market is too tight, but the solution isn’t to have less employment, but more people who want to work.”

Economists also say the Fed’s plan will be extremely difficult to pull off given the uncertainty of the post-pandemic world. Russia’s invasion has roiled global energy markets, with the widespread expectation that American households will feel the sting at the gas pump. Recent covid shutdowns at major Chinese manufacturing hubs have also renewed global supply chain woes, and offer a sobering reminder of the pandemic’s ongoing economic threat.

4.4 million in U.S. quit or changed jobs in February as turnover remained high

Lower prices are a top priority for millions who did return to work. Last month, Willie Price was called back to her longtime job after a pandemic layoff in spring 2020. Price, 62, has worked in food service at the Library of Congress for 42 years, and during the pandemic she scraped by, thanks to her morning paper route and other odd jobs. But she’s relied on her Library of Congress job to care for herself and her son.

She now earns $20.37 per hour — a small increase from before the pandemic — but said the pay doesn’t go nearly as far as before. She used to spend $135 a month for a parking spot, but now the garage she has to park in costs $400. She’s also paying for more gas to drive to Capitol Hill from her house in Maryland. And groceries cost so much more: She likes to cook salmon, shrimp and chicken, but now the “things that you like to eat are too expensive to eat.” Even with her old job at the Library of Congress finally back, Price said she doesn’t feel like the economy is working for her.

“I work from paycheck to paycheck to do what I got to do,” Price said. “I don’t have a big lump sum in the bank.”

Complicating this twin goal of tackling inflation and recalibrating the job market is that the Fed must do it all without causing businesses to lay people off or triggering a new recession. The Fed has an uneven track record of raising rates to cool down the economy just enough — many economists point only to 1994, when the Fed managed to hike interest rates and slow growth without causing the economy to contract altogether.

Fewer hot showers, less meat: How retirees on fixed incomes are dealing with inflation

History has often gone the other way. Since 1961, the Fed has launched nine full cycles of rate hikes to combat inflation. Recessions followed eight of those tries, according to research from the investment bank Piper Sandler.

“What Powell is saying is ‘this time is gonna be different,’ ” said Roberto Perli, a former Fed economist and now head of global policy at Piper Sandler. “Maybe there will be a time when it’s different. But that’s always a dangerous thing to say.”

Furman agreed that the Fed would be hard-pressed to cut inflation without causing consequences for the job market, saying: “The only thing I’m sure would work to lower inflation is an increasing unemployment rate.”

In a speech last month, Powell argued that the central bank’s track record with rate hikes was somewhat better, pointing to 1965 and 1984 as other instances in which the Fed fought overheating without putting the economy in trouble. And no one at the Fed says its plan will be easy to pull off. Interest rates can’t target specific gaps in the economy, and even back-to-back rate hikes operate with a lag.

Regardless, the economic expansion could depend on the Fed’s ability to get prices and the job market back to resembling something more normal.

“We need to get inflation under control for both sides of the mandate,” Cleveland Fed President Loretta Mester told reporters on a call in March. “If we want to sustain healthy labor markets, the best thing we can do is sustain the expansion, and that means it’s incumbent upon us to get inflation under control.”

Today’s economic forces are practically the opposite of what policymakers faced two years ago, when 20 million people lost their jobs and the Fed slashed rates to zero to help rescue the economy. For much of the pandemic, Fed leaders put off raising rates so the job market could have as much room as possible to heal. And until 2021, inflation wasn’t much of a problem. Powell and his colleagues focused on getting jobs back to their pre-pandemic strength, when a tight labor market lifted those who too often fell on the economy’s margins.

But the labor market of 2022 is showing a different kind of tightness, one that many policymakers and economists argue is fundamentally out of whack. As businesses hunt for workers, wages are rising, putting pressure on overall prices. At their policy meeting in March, Fed officials noted that their business contacts across the country reported having to pass on wage increases and the rising cost of doing business to customers. Economists warn that such a wage-price spiral can be an ever harder form of inflation for the Fed to interrupt.

At the same time, workers’ pay bumps have been rapidly eroded by the cost of basic necessities. Price increases have spread to every pocket of the economy, with the cost of gasoline, shelter and food driving the highest inflation in four decades. Economists don’t expect home prices or rent to fall anytime soon, and the war in Ukraine is dealing yet another blow to global energy and food prices.

The twin pressures of labor shortages and inflation have been particularly tough on restaurants, which depend on in-person contact and have been gutted by waves of the virus. The industry hasn’t recovered 820,000 jobs that were lost in the pandemic, according to Bureau of Labor Statistics data.

The pandemic shuttered three of Tyler Akin’s four restaurants on the East Coast, and he largely blames Congress for not providing enough relief to keep his industry afloat. Lately, he’s struggled to find enough staff for his French brasserie at the Hotel Du Pont in Wilmington, Del. Hiring bonuses, and paying to have a “preferred listing” on the job site Indeed, are now “a fixed cost of doing business,” he said.

That’s on top of the rising cost of staying open, Akin said. Packaging has become more expensive, as restaurants rely on takeout orders. Basic ingredients, especially proteins, are constantly going up in price. Then there’s the constant need to pivot with waves of the virus, since customer demand can drop off, then rebound so suddenly.

“The cost of labor is quite a bit higher, so you have these two forces — cost of goods inflation and labor cost inflation — that are creating the perfect storm,” Akin said.

Andrew Van Dam and Abha Bhattarai contributed to this report.