The ‘scariest economics paper of 2022’ has warned that a high unemployment rate will be necessary to combat inflation and to bring inflation down to 2 per cent, the US may need to tolerate unemployment of 6.5 per cent for at least two years.
The paper from the Brookings Institution by Johns Hopkins macroeconomist Larry Ball with co-authors Daniel Leigh and Prachi Mishra of the International Monetary Fund (IMF) found that “this unemployment path returns inflation to near the Fed’s target only under optimistic assumptions”.
“Under less benign assumptions about these factors, the inflation rate remains well above target unless unemployment rises by more than the Fed projects,” the paper said.
In a following opinion piece in The Wall Street Journal, Jason Furman, former chairman of the White House Council of Economic Advisers under President Obama, called this “the scariest economic paper of 2022”.
Based on Brookings’ findings, the Fed will need to be aggressive about raising rates even if unemployment continues to rise.
Furman said the US would need an average unemployment rate of about 6.5 per cent in 2023 and 2024 to hit its 2 per cent inflation rate target.
“While fighting inflation should be the central bank’s only focus today, at some point the Fed should reassess the meaning of victory in that struggle,” he wrote in WSJ.
After four decades of low US inflation, high inflation has emerged as a central economic problem of the Covid era.
Fed Chair Jerome Powell said on August 26 that “while higher interest rates, slower growth, and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses”.
“But a failure to restore price stability would mean far greater pain,” he stressed.