Why the jobs boom could worsen inflation and help trigger a recession

Wage growth has soared, but the good news could be a grim omen, economists said.

December 9, 2022, 5:04 AM

The economy has set off emergency sirens this year over growing recession fears, sky-high inflation and a battered stock market. But one area has allayed worries: jobs.

Hiring last month exceeded expectations and defied warnings of a downturn. Moreover, in November, wages grew a blistering 5.1% compared to a year earlier, offering welcome relief for workers strained by price hikes.

But the hiring boom could help send the economy into a prolonged downturn, turning the good jobs news into a grim omen, economists told ABC News.

"It's confusing for people and rightfully so," Betsey Stevenson, a professor of public policy and economics at the University of Michigan, told ABC News. "How can a lot of jobs be bad for the economy?"

A tight job market fuels rising wages, which often push companies to raise prices to make up for the added costs. In turn, inflation worsens and recession risks rise, they added.

In addition, rising wages have offered less to workers than they appear to have at first glance, since income gains have trailed the pace of inflation, effectively slapping workers with a pay cut, the economists said.

Here's what you need to know about how the hiring spree could deepen inflation and help trigger a recession, while leaving some workers worse off:

An inflation crisis puts pressure on the jobs market

Robust job growth could deepen inflation, but it isn't the primary cause of the current bout of high prices, economists said. Like so many economic problems, inflation comes down to an imbalance between supply and demand.

When billions of people across the globe faced lockdowns, they shifted consumption to goods like Peloton bikes and couches, in some cases bolstered by wallets fattened with government stimulus. Meanwhile, a pandemic-era supply chain bottleneck dramatically slowed the delivery of the goods people wanted. In turn, demand far outpaced supply, sending prices skyward.

This year, price hikes reached a 40-year high, triggering an aggressive series of interest rate hikes from the Federal Reserve meant to slash demand, slow the economy and curb costs. Price increases for some goods have cooled but remain highly elevated.

"I don't think anybody out there would tell you the main reason we have inflation today is businesses trying to chase too few workers," said Stevenson, of the University of Michigan.

But, she said, that could present a problem soon.

Fear of a wage-price spiral

PHOTO: Federal Reserve Chair Jerome Powell speaks at the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institute, Nov. 30, 2022, in Washington.
Federal Reserve Chair Jerome Powell speaks at the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institute, Nov. 30, 2022, in Washington.
Nathan Howard/AP

Alongside the dearth of goods, a shortage of workers emerged. A speedy recovery from the pandemic-induced recession caused a hiring blitz, but employers struggled to find workers, some of whom feared COVID exposure or sought early retirement.

The lack of workers has driven wages upward.

"If there are a lot of jobs and people are taking those jobs and the economy is growing, that's not bad. What's bad is if employers want to hire people and can't find people," Stevenson said. "We could start to see a lot of inflation generated by businesses trying to chase too few workers."

To be sure, some economists argue that a dearth of people seeking work owes to a lack of quality jobs that could lure potential workers off the sidelines, while others point out that record profits at some corporations suggest price increases owe in part to business opportunism, alongside supply-demand imbalance or wage pressure.

Still, it's no coincidence that the breakneck pace of wage growth last month coincided with a drop in the number of people working or seeking work. If workers are in ample supply, it gives the labor market some slack and limits wage growth. However, workforce participation came in at 62.1% last month, markedly lower than the pre-pandemic level of 63.4%.

"The underlying issue is that the labor force has shrunk," Beth Ann Bovino, chief U.S. economist at S&P Global, told ABC News. "I'm fearful that the wage gains put upward pressure on prices elsewhere."

When facing high inflation, policymakers ultimately fear what's referred to as a price-wage spiral, in which a rise in prices prompts workers to demand raises that help them afford goods, which in turn pushes up prices, leading to a self-perpetuating cycle of runaway inflation.

"Inflation is like a cancer where if you don't derail it, it can become a fatal problem," Diane Swonk, the chief economist at KPMG, told ABC News.

Interest rate hikes could plunge the economy into a recession

Seeing a relatively small workforce and strong wage growth, the Federal Reserve will likely continue its series of rate hikes to ward off a worst-case scenario of spiraling price increases, economists said.

While preventing a prolonged bout of inflation last seen in the 1980s, the continued interest rate hikes will put further brakes on the economy and increase the likelihood of a recession, they added.

"When the Fed comes in with higher rates, it takes the punch bowl away and the party is over," said Bovino, of S&P Global. "If the Fed has to ramp up rates even higher because of wage pressures feeding into other areas, the Fed takes the punch bowl and smashes it to the ground."

So far, the hiring boom has withstood the Fed's effort to slow the economy. But the job market has shown signs of wobbling, such as a string of layoffs in the tech sector that has struck stalwarts like Amazon and Facebook-parent Meta.

As the economy slows, wage growth will cool and more workers will lose their jobs, but the economy will avert a more debilitating downturn, said Swonk, of KPMG. Eventually, inflation will fall to a rate below that of wage growth, no longer eating away at workers' income, she added.

"Unemployment will rise a bit – that's a hard thing, no question about it," Swonk said. "But it is better to eradicate the risk that this inflation metastasizes and we have to take a much more severe scarring, a deep and disruptive recession."

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