Why Higher Unemployment Is Good News Now
Very rarely should you celebrate rising unemployment. This is one of those times. Friday’s news that the unemployment rate rose to 3.8% in August, an 18-month high, is one of several recent signs that the labor market has softened significantly.
This is a necessary stage in the Federal Reserve’s campaign to bring inflation back down to 2%, and keep it there. It isn’t enough to ensure we avoid a recession, but it helps. Why does the labor market matter so much? After all, inflation has already fallen without it weakening.
The answer comes down to the difference between headline and underlying inflation. Headline inflation—the published increase in prices—shot from under 2% in early 2021 to 9.1% in June 2022 because of snarled supply chains; stimulus- and lockdown-fueled goods purchases; and rising oil prices following Russia’s invasion of Ukraine. It then fell below 4% this year thanks to falling oil prices and airfares, slowing rent increases and cheaper health insurance.
The question is: Where is underlying inflation (i.e., the rate that prevails once all these idiosyncratic influences wash out)? This depends heavily on the balance between total supply and demand, of which the labor market is the best barometer. Simply put, even if inflation falls to 2%, it won’t stay there if the labor market is so tight that wages rise faster than is compatible with inflation of 2%. To be sure, August’s rise in unemployment is just one month’s data, and some economists played it down because it reflected a summer surge of people joining the labor force.
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