Jerome H. Powell, the chair of the Federal Reserve, spent the early pandemic lamenting something America had lost: a job market so historically strong that it was boosting marginalized groups, extending opportunities to people and communities that had long lived without them.
“We’re so eager to get back to the economy, get back to a tight labor market with low unemployment, high labor-force participation, rising wages — all of the virtuous factors that we had as recently as last winter,” Mr. Powell said in an NPR interview in September 2020.
The Fed chair has gotten that wish. The labor market has recovered by nearly every major measure, and the employment rate for people in their most active working years has eclipsed its 2019 high, reaching a level last seen in April 2001.
Yet one of the biggest risks to that strong rebound has been Mr. Powell’s Fed itself. Economists have spent months predicting that workers will not be able to hang on to all their recent labor market gains because the Fed has been aggressively attacking rapid inflation. The central bank has raised interest rates sharply to cool off the economy and the job market, a campaign that many economists have predicted could push unemployment higher and even plunge America into a recession.
But now a tantalizing possibility is emerging: Can America both tame inflation and keep its labor market gains?
Data last week showed that price increases are beginning to moderate in earnest, and that trend is expected to continue in the months ahead. The long-awaited cool-down has happened even as unemployment has remained at rock bottom and hiring has remained healthy. The combination is raising the prospect — still not guaranteed — that Mr. Powell’s central bank could pull off a soft landing, in which workers largely keep their jobs and growth chugs along slowly even as inflation returns to normal.
“There are meaningful reasons for why inflation is coming down, and why we should expect to see it come down further,” said Julia Pollak, chief economist at ZipRecruiter. “Many economists argue that the last mile of inflation reduction will be the hardest, but that isn’t necessarily the case.”
Inflation has plummeted to 3 percent, just a third of its 9.1 percent peak last summer. While an index that strips out volatile products to give a cleaner sense of the underlying trend in inflation remains more elevated at 4.8 percent, it, too, is showing notable signs of coming down — and the reasons for that moderation seem potentially sustainable.
Housing costs are slowing in inflation measures, something that economists have expected for months and that they widely predict will continue. New and used car prices are cooling as demand wanes and inventories on dealer lots improve, allowing goods prices to moderate. And even services inflation has cooled somewhat, though some of that owed to a slowdown in airfares that may look less significant in coming months.
All of those positive trends could make the road to a soft landing — one Mr. Powell has called “a narrow path” — a bit wider.
For the Fed, the nascent cool-down could mean that it isn’t necessary to raise rates so much this year. Central bankers are poised to lift borrowing costs at their July meeting next week, and had forecast another rate increase before the end of the year. But if inflation continues to moderate for the next few months, it could allow them to delay or even nix that move, while indicating that further increases could be warranted if inflation picked back up — a signal economists sometimes call a “tightening bias.”
Christopher Waller, one of the Fed’s most inflation-focused members, suggested last week that while he might favor raising interest rates again at the Fed meeting in September if inflation data came in hot, he could change his mind if two upcoming inflation reports demonstrated progress toward slower price increases.
“If they look like the last two, the data would suggest maybe stopping,” Mr. Waller said.
Interest rates are already elevated — they’ll be in a range of 5.25 to 5.5 percent if raised as expected on July 26, the highest level in 16 years. Holding them steady will continue to weigh on the economy, discouraging home buyers, car shoppers or businesses hoping to expand on borrowed money.
So far, though, the economy has shown a surprising ability to absorb higher interest rates without cracking. Consumer spending has slowed, but it has not plummeted. The rate-sensitive housing market cooled sharply initially as mortgage rates shot up, but it has recently shown signs of bottoming out. And the labor market just keeps chugging.
Some economists think that with so much momentum, fully stamping out inflation will prove difficult. Wage growth is hovering around 4.4 percent by one popular measure, well above the 2 to 3 percent that was normal in the years before the pandemic.
With pay climbing so swiftly, the logic goes, companies will try to charge more to protect their profits. Consumers who are earning more will have the wherewithal to pay up, keeping inflation hotter than normal.
“If the economy doesn’t cool down, companies will need to bake into their business plans bigger wage increases,” said Kokou Agbo-Bloua, a global research leader at Société Générale. “It’s not a question of if unemployment needs to go up — it’s a question of how high unemployment should go for inflation to return to 2 percent.”
Yet economists within the Fed itself have raised the possibility that unemployment may not need to rise much at all to lower inflation. There are a lot of job openings across the economy at the moment, and wage and price growth may be able to slow as those decline, a Fed Board economist and Mr. Waller argued in a paper last summer.
While unemployment could creep higher, the paper argued, it might not rise much: perhaps one percentage point or less.
So far, that prediction is playing out. Job openings have dropped. Immigration and higher labor force participation have improved the supply of workers in the economy. As balance has come back, wage growth has cooled. Unemployment, in the meantime, is hovering at a similar level to where it was when the Fed began to raise interest rates 16 months ago.
A big question is whether the Fed will feel the need to raise interest rates further in a world with pay gains that — while slowing — remain notably faster than before the pandemic. It could be that they do not.
“Wage growth often follows inflation, so it’s really hard to say that wage growth is going to lead inflation down,” Mary C. Daly, president of the Federal Reserve Bank of San Francisco, said during a CNBC interview last week.
Risks to the outlook still loom, of course. The economy could still slow more sharply as the effects of higher interest rates add up, cutting into growth and hiring.
Inflation could come roaring back because of an escalation of the war in Ukraine or some other unexpected development, prodding central bankers to do more to ensure that price increases come under control quickly. Or price increases could simply prove painfully stubborn.
“One data point does not make a trend,” Mr. Waller said last week. “Inflation briefly slowed in the summer of 2021 before getting much worse.”
But if price increases do keep slowing — maybe to below 3 percent, some economists speculated — officials might increasingly weigh the cost of getting price increases down against their other big goal: fostering a strong job market.
The Fed’s tasks are both price stability and maximum employment, what is called its “dual mandate.” When one goal is really out of whack, it takes precedence, based on the way the Fed approaches policy. But once they are both close to target, pursuing the two is a balancing act.
“I think we need to get a 2-handle on core inflation before they’re ready to put the dual mandates beside each other,” said Julia Coronado, an economist at MacroPolicy Perspectives. Forecasters in a Bloomberg survey expect that measure of inflation to fall below 3 percent — what economists call a “2-handle” — in the spring of 2024.
Mr. Powell has regularly said that “without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all,” explaining why the Fed might need to harm his prized job market.
But at his June news conference, he sounded a bit more hopeful — and since then, there has been evidence to bolster that optimism.
“The labor market, I think, has surprised many, if not all, analysts over the last couple of years with its extraordinary resilience,” Mr. Powell said.