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The State of the Economy

Published on 6/4/2022
On the economy, there’s good news, and there’s bad news.

The good news is a historically low unemployment rate, at 3.6%. While we saw similar unemployment rates immediately before the pandemic, before 2019 we have to go back to 1969 to find unemployment rates that low. Unemployment rose to 14.7% during the pandemic, but employment has quickly recovered, thanks in large part to the strong policy response.

Two factors contribute to this low unemployment rate: demand is high, and labor force participation is low. Many workers chose to quit or retire early during the pandemic, and not everyone has returned to the labor force. Access to child care is still a problem keeping some people from working. The labor force, which includes those looking for work as well as those employed, fell from 63.4% of the adult population in Feb. 2020 to 60.2% in April 2020; recovery has been slow, and we are currently at 62.2%, still below where we were before the pandemic.

Many employers are finding it difficult to hire workers. This gives workers more bargaining power, allowing them to get higher wages and better working conditions. It also contributes to supply-chain issues that started during the pandemic and continue to persist.

The bad news is high inflation, at 8.3%. This is the highest inflation has been since 1982. Most people don’t remember a time when inflation was this high.

The causes of inflation are not difficult to find. Pandemic shutdowns and supply chain disruptions reduced the supply of goods available, while stimulus checks supported demand. The result was rising prices. Stimulus spending during the pandemic was five times as high as the stimulus bill passed for the 2008 recession. This is a good thing because it supported the incomes of people forced to stay home to limit the spread of Covid, and it supported the rapid recovery of employment. But the stimulus did have costs. With more income chasing fewer goods, prices rose.

Inflation had already started to become a problem when we were hit by a second dose of inflation, this time due to the war in Ukraine. Sanctions on Russian oil and gas have increased energy prices; this is most visible at the gasoline pump, but affects the prices of everything using energy as an input. Ukraine is an important exporter of wheat and sunflower oil, and the war has made it more difficult to harvest and export these products, so supply is down and prices are up. We can grow more wheat and oil, but farmers are facing higher prices for fertilizer, which is made from petroleum.

What can be done about inflation? We know how to reduce inflation, the problem is that the medicine has painful side effects. The Federal Reserve can reduce inflation by increasing interest rates, but higher interest rates will slow the economy, causing higher unemployment. So policymakers have a difficult choice: do we increase unemployment in order to keep inflation under control, or do we keep unemployment low and allow high inflation to persist? The Federal Reserve’s mandate it to maintain stable prices and employment, so it has a difficult balancing act to perform. The Fed has already started to increase interest rates, and this will increase the unemployment rate. We hope that it can stop inflation without causing a recession, but that remains to be seen.