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Yes, the Labor Market Is Strong. But the US Economy Is In Trouble

US Economy 2022
Image of US Currency. Image Credit: Creative Commons.

Today’s strong job numbers are bound to confirm the Federal Reserve’s view that the economy is running too hot and that there is every reason to worry about inflation. That will encourage the Fed to stick to its plan announced at this week’s FOMC meeting of aggressive monetary policy tightening. It will also heighten the chances that the economy will have a hard landing by year-end, not least because of the bursting of the equity and housing market bubbles.

According to the Labor Department, the US economy remains robust. The economy added yet another 428,000 new jobs and not only did the unemployment rate at 3.6 percent remained close to its pre-pandemic low. Average hourly wages grew at a 5 ½ percent clip suggesting that it will be far from easy for the Fed to slay the inflation beast.

Earlier this week, concerned about an overly hot economy and the associated surge in inflation to a forty-year high, the Fed moved decisively towards a very much more hawkish monetary policy stance. It took the unusual step of hiking interest rates by 50 basis points rather than the usual 25 basis points and it indicated that it would very likely hike interest rates again by 50 basis points at each of its next two meetings.

Not getting the attention it deserves, the Fed also indicated that it would reduce the size of its balance sheet at a more rapid rate than was done by either the Bernanke or the Yellen Feds. Specifically, it announced that it plans to reduce its balance sheet by $47 billion a month over the next three months and by $95 billion a month during the remainder of the year. It would do so by not rolling over its extensive holdings of Treasury bonds and mortgage-backed securities at maturity.

As today’s strong job numbers suggest, there can be no question that the Fed was undoubtedly justified in moving to a more hawkish policy stance to reduce consumer inflation from its current 8 ½ percent rate of increase. However, the question remains whether the Fed is slamming on the monetary policy brakes too hard by committing to a series of 50 basis point interest rate hikes and to a series of very large balance sheet reductions. This would seem to be especially the case in the context of signs that the overly valued equity market is already swooning with the S&P 500 having lost around 15 percent in value since the start of the year.

Of particular concern must be the Fed’s proposed $215 billion shift in liquidity provision to the markets. This shift will occur as the Fed moves from a position where it was providing the markets with $120 billion a month through its bond purchases through most of last year to one in which it will be draining $95 billion a month by the fall through not rolling over its bond holding. This shift has to raise a few fundamental questions.

If providing $120 billion a month in liquidity last year created bubble-like conditions in the equity, housing, and credit markets, why will withdrawing $95 billion a month later this year not cause those bubble-like conditions now to burst? If flooding the markets with liquidity last year allowed the emerging market economies to become over-indebted, why will withdrawing liquidity on a massive scale not bring in its wake the wave of emerging market defaults about which the World Bank has been warning?

All of this does not bode well for the Fed attaining a soft economic landing or for the labor market remaining strong by yearend. It also does not bode well for the Fed’s credibility when it is forced to make yet another policy U-turn to support disorderly financial markets.

Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.

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Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and multilateral lending agencies.

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