However, with inflation at what it is, the wage freeze is essentially an 8 percent pay cut. That’s enough to create cash-flow problems for many families, especially those who can’t afford to pay off their mortgages as rates on consumer credit rise quickly. Nor can they succeed by putting overtime on the job because the flexible employee hours are reduced. Worse, there is an amplifier effect. As more companies turn to strategies like wage freezes and reduced overtime to protect core workers, all households have less choice to deal with a cash deficit and core workers are less exposed to inflation eroding their incomes.
On the other side of the spectrum, employers may be keenly aware that raises are necessary so their core employees can continue to pay the higher cost of daily necessities such as food and energy. To accomplish this, employers can fire workers who are outside the core group. Doing so allows businesses to better protect people who are likely to still be with them when conditions begin to improve. The problem, however, is that protecting core workers against the ravages of inflation increases the cost per worker for businesses, and that itself contributes to inflation. This scenario leads to the frightening misalignment of inflation expectations that the Federal Reserve fears most. This means that even if inflation slows down a bit, a large increase in unemployment is required as those workers who are still employed retain their purchasing power.
Together, the two blades imply that the Fed’s attempt to lower inflation expectations by increasing interest rates will lead to a sharp and contagious increase in financial instability for working-class households or a distortion of inflation expectations that result from are made by businesses. In either case, the damage to working-class families may be more severe than anyone anticipated as high levels of inflation pose risks not seen since at least the mid-1970s, when the economy last turned around. . structural high inflation. At the time, about half of the baby boomers were full-time adults. The younger half of that generation and those following have not experienced the difficulty of adjusting to sudden, unexpected, and persistent inflation.
There is no obvious way to solve dual dynamic problems. As the problems worsen, the risks of being too slow to solve them grow. Alternatively, the potential side effects associated with problem solving increase rapidly. It is difficult to predict where and how those effects will be balanced. The Fed chose the fast path of aggressive rate hikes, confident that there will be no repeat of the financial instability that followed former Chairman Alan Greenspan’s extreme rate hikes between 2004 and 2006 thanks to new rules and regulations the bank has created. safer system.
I support the Fed’s current path, and I have no doubt that those new safeguards have made the financial system more stable. Even so, I wouldn’t be surprised if policymakers find themselves with some financial instability that no one anticipates, because it’s precisely the new risks that this new inflationary environment creates that create the most from inflation and containment if the Fed moves too quickly. to bring inflation. return to your goal.
More from Bloomberg Opinion:
• The Global Central Bank May Have Come: Daniel Moss
• Fed Teaches Americans Lesson in Delay: Alison Schrager
• Fed Overcomes Pain to Fight Inflation: Bill Dudley
This column does not necessarily reflect the editorial opinion of Bloomberg LP or its owners.
Karl W. Smith is a columnist for Bloomberg Opinion. Previously, he was vice president of federal policy at the Tax Foundation and assistant professor of economics at the University of North Carolina.
More stories like this are available at bloomberg.com/opinion
