The Fed Must Act Now to Prevent a Job Market Breakdown

The labour market was a bright spot in America’s economic boom for the first three years of the pandemic recovery. However, recent indicators suggest that the job market is losing momentum. This cooling off is worrisome because unemployment tends to be inertial—once it starts to rise, it tends to continue. To prevent a further increase inunemployment, the Federal Reserve must act quickly to support the economy by lowering interest rates.

The Job Market at a Turning Point

Between April 2020 and April 2023, the US economy added 25 million jobs, with the unemployment rate reaching a 54-year low of 3.4%. This remarkable recovery brought significant wage gains, particularly for lower-end service occupations. However, the narrative has shifted in the past year. By the first half of 2024, the unemployment rate had climbed to 4.1%, an increase of 0.7 percentage points from its historic low, translating to 1.1 million more unemployed Americans since April 2023.

This rise in unemployment is not an isolated statistic. Job openings have declined, and the quit rate in the private sector has dropped, signalling that workers are becoming more cautious about their employment prospects. Economic data also points to a slowdown, with real GDP growth averaging a sluggish 1.4% in the first half of the year.

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The Fed’s Role in Stabilising the Economy

The Federal Reserve’s recent focus has been combating inflation through interest rate hikes. However, with inflation now largely under control, the risks have shifted towards the labour market. If the Fed waits too long to lower interest rates, it could exacerbate the deterioration of the job market. The current 4.1% unemployment rate exceeds the Fed’s year-end projection, indicating that the job market is weakening faster than expected.

Signs of a Slowing Economy

Two significant factors suggest that economic growth may not improve in the second half of the year. First, the outlook for residential construction has weakened, as evidenced by a decline in building permits. Second, consumer spending is slowing, with retail sales and food services remaining flat for the past five months. Given these indicators, the labour market’s outlook is likely to worsen if the Fed does not act.

The Need for Immediate Rate Cuts

The Fed must balance its dual mandate of maximising employment while controlling inflation. With inflation now cooling and the labour market weakening, the Fed should pivot its focus towards supporting employment. The core personal consumption expenditures price index, the Fed’s preferred measure of inflation, is running at roughly 2.5%, suggesting that inflation is no longer a pressing concern.

The Taylor rule, a guideline for setting interest rates based on the unemployment rate and inflation, suggests that the Fed should lower rates to between 4.5% and 4.75%. This would imply three or four 0.25% rate cuts, a modest adjustment that could stabilise the job market without risking runaway inflation.

Avoiding Past Mistakes

Some policymakers fear that easing rates too soon could repeat the mistakes of the 1970s when premature cuts led to a resurgence of inflation. However, this concern is misplaced. Inflation is a lagging indicator reflecting past monetary policy. Because inflation has already slowed, the Fed can afford to cut rates without risking a repeat of the past.

Even if a small rate cut proves a mistake, it would be relatively easy to reverse. As Fed Chair Jerome Powell noted, the impact of a single 25-basis-point rate cut on the economy would be minimal. Therefore, the Fed should proceed with cautious rate cuts to support the labour market.

Conclusion

The labour market is showing signs of strain, and the risks of further unemployment increases are significant. With inflation under control, the Federal Reserve should shift its focus to supporting employment by lowering interest rates. Acting now with modest rate cuts will help stabilise the job market and prevent a deeper economic downturn. Now is the time for the Fed to act before the situation worsens and requires more drastic measures.

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