Unemployment may need to be higher than Fed predicts to fight inflation

The battle to bring down inflation may be more painful than the Federal Reserve has let on. A new economic paper presented at a Brookings conference Thursday predicts inflation will remain well above target unless unemployment rises by more than the Fed projects.

The Fed has previously said it expects unemployment will hit 4.1% by the end of 2024 — it’s 3.7% now. It also forecast personal consumption expenditures inflation will drop to 2.2% by the end of 2024, down from 6.3% currently.

“If you make quite-optimistic assumptions, we might get something close to what the Fed expects,” Johns Hopkins University economist Laurence Ball told Brookings. “But if either the labor market doesn’t behave, or expectations don’t behave, the small increase in unemployment the Fed projects won’t be enough.”

In periods of high inflation in the 1970s and 1980s, the unemployment rate pushed as high as 10.8% before inflation finally, dramatically dropped.

“We need to act now, forthrightly and strongly, and keep at it until the job is done to avoid that,” Fed Chair Jerome Powell said Thursday. “We think we can avoid the high social costs that Paul Volcker and the Fed had to bring into play in order to get inflation back down and set us up for a long period of price stability.”

This week, Goldman Sachs updated its forecasted Fed rate hikes, penciling in a 75 basis point increase this month and 50 basis points in November, both 25 bps higher than previously forecast.