By Howard Schneider

WASHINGTON (Reuters] – When the U.S. had a unemployment rate below 3% the year before, one Federal Reserve official said, it was due to the Korean War. A recession which saw countless workers losing their jobs was also nearing the end.

The circumstances may have been unusual but it still presented an unfamiliar pattern: a declining unemployment rate eventually leading to recession. Fed officials are now under pressure to stop this trend as they slow inflation and keep the economy growing while providing strong gains to workers.

The current optimism in the strength of the labor market is evident when James Bullard, President of St. Louis Fed, stated last week that he expected the U.S. unemployment to drop below 3% this fiscal year. Economists should be wary of this flashback to 1950s.

This low unemployment rate indicates that the economy has reached a critical point. The U.S. central banks pushed for greater aggressiveness, according to Tim Duy of the University of Oregon, who is also the chief economist of SGHMacroadvisers. I don’t think there is any way to reduce inflation and avoid triggering recessions with the associated rise in unemployment.

This is a tradeoff, of jobs to price control that the Fed felt had lost its relevance. Prior to the coronavirus epidemic, the unemployment level was at 3%. This showed that the economy can put more people in work, while prices remain stable.

‘HARD LANDING’ AHEAD?

That debate was rekindled after the pandemic. It raised concerns about inflation and whether the American work options, or the entire global economy will be the same as the ones that were in place before mass infection, fear, lockdowns, and two years ago.

For example, in 2019, the unemployment rate was around 3.5% and inflation failed to reach the Fed’s target of 2%. In 2022, there was a worldwide tangle in supply chains, worker reluctance, and ongoing pandemic. The unemployment rate hovered around 4%. Businesses wanted more people than they could hire, which was almost triple what the Fed had set for.

Officials at the U.S. central banks believe they are able to avoid a “hard landing”, as they embark on what Fed Chair Jerome Powell calls a gradual removal of low interest rates. This will also include other measures that should help the economy get through this pandemic. At this stage, policymakers support the approach with the expected first rate increase next month.

But despite the apparent agreement between them, there’s a slight divide between those who feel that most current inflation is tied to the pandemic. It will likely end on its own. Those who believe the Fed alone will be doing the majority of the work to reduce inflation and raising interest rates sufficiently to slow the economy will remain divided.

In simple terms, the difference in inflation direction is just timing. If it moves in one way or another, policymakers will be affected. Fundamentally, it is about the evolution of the economy since March 2020. That debate will determine how future economic data are interpreted. It also affects how quickly monetary policy can veer in either direction and whether inflation can be controlled without going into a recession.

MISTAKES – POTENTIAL

Bullard said, in a Reuters interview: It was too early to suggest that the Fed had fallen behind in fighting inflation. He said that the central bank was well-positioned to take on what was required.

He also stated that monetary policy would play a major role in the fight against inflation by controlling inflation expectations and limiting demand with higher interest rates. He expressed doubts that any improvements in the global supply chain, return of people to work, or any other improvement would provide immediate help, and the Fed could proceed more aggressively.

He said, “I’m not blind to supply-side arguments.” While policymakers agree on initial rate hikes, “there will come a time in the future when it will be more difficult to make a decision…How much would you like to tighten your policy and what are the risks of recession?”

Neel Kashkari, Minneapolis Fed President, has stated that rates need not rise much. It’s more like an acceleration pedal being pressed rather than the brakes.

Both mistakes and recession risk can be made in either direction. Doing too little will allow inflation to grow deeper; or doing too much, it could cause a downturn.

UNPREDICTABLE data

Friday’s Labor Department jobs report, January 2017, was published earlier. It showed the Fed struggling to deal with an environment in which neither employment nor prices – two of the pillars of their policy mandate – are performing as expected.

Numerous analysts predicted that last month’s economic downturn was due to an unprecedented rise in COVID-19-related cases. Businesses also had to scale back because of sickness or outright caution.

However, the report showed that employers created 467,000 new jobs and wage increases, which is a result of pressures in the economy, even though there was an increase in Omicron virus infections.

Surprise to the opposite side: The labor force participation increased and the unemployment rate actually edged upwards a tenth percent of a point. This trend, if it is established, could be in favor of a more aggressive Fed.

However, as things stand, economists at Jefferies Aneta Marcowska and Thomas Simons said that they have to accept the numbers “as is” with a view of an “inflationary labor market.” They also noted that the Fed will likely move towards a “more sustained tightening and a greater terminal rate,”