The Fed Is Taking a Blunt Instrument to the Economy

With an economic system that seems so brutal and unpredictable, is there any wonder at the rising political discontent? But there are, in fact, policies and practices that can help moderate wild inflationary swings and support the Fed’s efforts to restore stable prices more gently. Such measures may be of little assistance this time, given how the collapse in stocks already seems to be pricing in the worst, but they will limit the collateral damage from future cycles.

Labor flexibility: Nimble companies are at the heart of America’s economic success, but managers are often too quick to shed workers in a downturn before scrambling to hire them back when demand returns. Selling low and buying high is the worst kind of economic stewardship, beyond the damage to operational efficiency and culture. It also clearly aggravates current inflation pressures as firms scoop up every last flight attendant, dockworker, and waiter. 

In contrast, European companies kept employees attached to their jobs, paying a reduced salary with government support. American managers cringe at continental employment practices they see as heavy-handed and wasteful, but the European approach clearly worked in this crisis. Unemployment peaked much lower than in the U.S. after the onset of the pandemic and has now fallen to historical lows despite labor participation at its highest ever. Inflation also looked far more manageable, at least until the Russian invasion disrupted global commodity markets.

Labor supply: With all the talk of post-pandemic retirements, America would also benefit from having more—and more flexible—workers.  Women are just now recovering their places in the workforce, having suffered disproportionately from lockdown layoffs and family care commitments. But the current 56.8% female participation rate lags countries like Canada, the United Kingdom, and Norway. It’s a complex issue, but adjustable schedules and more affordable child care would expand the supply of workers and dampen large, cyclical wage swings.

Net migration, which has fallen substantially since 2016, would help, too. Not only do immigrants increase the labor supply, they are usually much more mobile and willing to move where the jobs need filling, all of which helps cool desperate bidding up of labor costs when firms get desperate. 

Fiscal targeting: 2020’s shocking jobless spike also triggered huge stimulus flows to households, whether they needed them or not. Most did, but the extraordinary $2.5 trillion in excess balances sitting in U.S. bank accounts fueled a spending boom and consumer inflation unseen since the 1980s. With inflation still raging, the government is left with blunt instruments like gas tax holidays and tariff cuts that barely ease the pain while actually working against the Fed’s efforts to cool demand.

Properly calibrating stimulus is hard even without a crisis, but the government needs better mechanisms for disbursing aid. This includes modernized Internal Revenue Service systems, improved means to reach those who don’t file tax returns, and faster payments plumbing. If distributed ledger technologies and digital dollars make it easier and cheaper to transfer money, disbursements can be better calibrated and reduced as recovery takes root. 

Fatter inventories: Long gone are the days when business schools celebrated the virtues of “just in time” deliveries, which kept operations lean and profits high. The pandemic itself delivered a wake-up call to the risks of running out of personal protective equipment, but the booming recovery demonstrated we need more warehouses full of everything from laptops to garden gnomes.

Obviously, firms can’t hold everything in stock, but they can develop more reliable supply lines to avoid the frenzied price increases for scarce items. This doesn’t mean moving all factories back to America, but it does include lining up more than one supplier and depending on more than one port of entry. 

Competition policy: It’s too easy to blame corporate greed for high prices, as the Biden administration has, denouncing meat packers and oil drillers. Still, inflation has been aggravated in areas where there is less competition to keep prices low. Scholars have documented how the rise of corporate concentration in airlines, mobile telecommunications, and healthcare have driven prices higher relative to European equivalents. 

Fixing this requires complex changes in law and policy to strike the right balance between consolidation that creates efficiencies and competition that keeps prices low. Even the slightest improvement on the margin, though, makes the Fed’s inflation battle that much easier.  

Any adjustment that brings more flexibility to goods and services markets can help stabilize prices through cyclical swings. Any measure that alleviates the Fed’s burden also reduces the collateral damage of the adjustment in bankruptcies and joblessness. None of these reforms is automatic or easy, but without trying, we are merely bracing for the bad guy with the club.

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