June 21, 2022

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By Jeanna Smialek

Economics Reporter

Good morning. The government's plan to fight inflation could cost jobs and restrict wage growth.

Shopping for food in Brooklyn last week.Spencer Platt/Getty Images

Rocky road ahead

Americans' household finances are headed for a rough patch.

Consumer prices are climbing at the fastest pace since 1981, and given the breadth of today's rapid inflation — which is showing up in costs as diverse as airfares and apartment rents — it is unlikely to fade fully on its own. The government's efforts to wrestle it down will most likely prove painful for many working families.

The country's main tool for fighting price increases is Federal Reserve policy. The Fed is trying to bring inflation back under control by raising interest rates, which sets off an economy-cooling chain reaction. Higher interest rates increase the cost of mortgages and company borrowing, which slows business growth and translates into less hiring. As the job market weakens, paycheck growth slows, which further tamps down buying. Less shopping gives supply a chance to catch up.

The challenge for many working families is that their wages might slow down before price increases do. Fed officials predicted last week that unemployment would begin creeping up by the end of the year but that inflation would remain elevated at 5.2 percent.

That means that consumer buying power is likely to erode, after several months in which wage growth has already failed to keep up with rising prices. At the same time, rising rates have unsettled markets and prompted stock prices to plummet, chipping away at many household nest eggs. Higher mortgage costs are slowing the housing market and could lower home values, further cutting into wealth — because for many families real estate makes up a big chunk of net worth.

As incomes and household balance sheets take a beating, many Americans may wonder: Isn't there a better way to deal with inflation? Today, I will explain why policymakers are choosing this painful path.

The explanation

Prices generally jump when consumers and businesses demand more goods and services than companies are able, or willing, to supply. To use a recent example, demand for cars bounced up last year, but car companies could not ramp up production fast enough to meet the surge amid a parts shortage. As shoppers competed for a finite supply of sedans and pickup trucks, prices skyrocketed.

Fed policy works on the demand side of that equation. When fewer people shop for cars, because auto loans are expensive and the job market feels less secure, a smaller supply of vehicles might be enough to go around without causing prices to shoot up.

But crushing demand ranks somewhere between unpleasant and agonizing. When the Fed pushed interest rates to double-digit levels in the early 1980s, in an effort to bring down rapid inflation, it set off brutal back-to-back recessions that pushed the unemployment rate to nearly 11 percent. (Right now, the rate is at a historically low 3.6 percent.)

A car dealership in Miami.Chandan Khanna/Agence France-Presse — Getty Images

That grim historical example has prompted some labor-focused groups to call for a more holistic response to today's price increases, which are the result of both strong demand and disrupted supply.

The White House and Congress could help to ramp up production in key parts of the economy, offering relief on the supply side of the inflation equation.

The issue is partly one of timing. While the government can try — and is trying — to help build more affordable housing, for instance, those policies take a while to have an effect. By the time they help, consumers and businesses may have come to expect fast inflation. And with prices, expectations can be self-fulfilling: Workers who anticipate heftier rent and grocery bills might demand higher pay to cover those costs, prompting their employers to raise prices to cover climbing labor expenses and setting off an inflationary cycle.

That is one reason the Fed is stepping in with its painful, but quicker, tool.

The bottom line

The Fed last week lifted interest rates by the largest increment since 1994, while signaling that it expects to raise them more this year than it did over the entire economic expansion stretching from 2009 to 2020.

Even if it doesn't cause a full-blown recession, the Fed's approach is expected to hurt, and it's already tanking stocks. But officials contend that allowing inflation to go unchecked would be worse, in part because it would stoke uncertainty and hurt low-income people with limited wiggle room in their budgets.

For more

President Biden said that he was considering suspending the federal gas tax to ease fuel prices.
Nearly four dozen countries raised interest rates in the past six months to try to rein in inflation.
Here's more on what is causing inflation and how it is measured.
When the Fed raised rates last week, it signaled that another increase would be on the table next month.

Continue reading the main story


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Natasha Frost, Ian Prasad Philbrick and Tom Wright-Piersanti contributed to The Morning. You can reach the team at themorning@nytimes.com.