September 23, 2022
Catherine Rampell’s latest Washington Post column argued that lower-income people have been hardest hit by inflation, so they will benefit most if the Fed gets inflation under control. The argument is that items that they must buy, like food, gas, and rent, have risen most rapidly in price. Furthermore, since lower-income people tend to already be buying lower-priced brands, they have little ability to protect themselves against inflation by switching to less expensive alternatives.
There are two problems with this logic. As many of us have noted, and Rampell acknowledges, workers at the bottom end of the wage distribution have seen wage increases well above the average over the last two years. If the unemployment rate were to rise by a percentage point or more (it could rise by much more), we would almost certainly see the more rapid wage gains at the bottom come to an end.
In fact, the story could well go into reverse. Over the last four decades, wage gains for the bottom half of the wage distribution trailed average wage growth, this is especially true during periods of high unemployment. In fairness, if the unemployment rate stays under 5.0 percent, this would still qualify as a period of relatively low unemployment, but there is no guarantee that workers at the bottom would be seeing wage gains equal to the average pace of wage growth.
There is also the issue of the distribution of unemployment. Relatively few doctors and computer scientists are likely to face unemployment as a result of the Fed’s rate hikes. The people who lose their jobs will be disproportionately retail and restaurant workers and others employed in a low-paying sector.
The Black unemployment rate is on average twice as high as the unemployment rate for whites. For Hispanics, the ratio is roughly 1.5 times as high. If the unemployment rate for whites rises by 1.0 percentage points, this means we can expect a rise in the unemployment rate for Blacks of around 2.0 percentage points and 1.5 percentage points for Hispanics.
It is very difficult to see how families who have one or more member going from being employed to being unemployed can benefit from the Fed’s fight against inflation. These families will be unambiguous losers in this story. Also, since most spells of unemployment are short, there will actually be a large number of families who are in this situation over the course of a year or two.
Will the Fed’s Fight Slow Inflation in the Staples?
If we want to make the argument that the Fed has to fight inflation to help lower-income people, then we would have to believe that higher rates will be especially effective in slowing inflation in food, energy, and rent. That is not obviously the case.
Starting with food, the jump in prices since the pandemic was largely a worldwide phenomenon. We saw big increases in the price of wheat and many other commodities associated with supply chain disruptions from both the pandemic and the war in Ukraine.
These prices are now headed downward as the world economy is adjusting to these disruptions. Reducing demand in the United States can help relieve the stress in these markets, but U.S. demand has only a limited impact on the world market.
In some cases, the Fed’s rate hikes will provide almost no benefit. For example, Avian flu devastated the U.S. chicken stock, pushing up both the price of chicken and eggs. Fed rate hikes will not help this story much. In short, it is not likely that the Fed’s rate hikes will save people much on food.
There is a similar story with gas and energy more generally. These prices are determined on a world market. The U.S. is a major user of energy, but still only accounts for around a fifth of world demand. Reducing U.S. consumption by 2-3 percent (a large reduction) will not have a big impact on world prices.
There is an issue of the “crack spread,” the gap between the price of a gallon of gasoline and the cost of the oil contained in it. That had exploded earlier this year, arguably because of oil companies using monopoly power to limit supply, but has now fallen back to more normal levels. This spread can be affected somewhat by domestic demand, but it accounts for less than 20 percent of the price of a gallon of gas.
Finally, there is rent. The Fed’s rate hikes had an immediate and large impact on home sales. Mortgage rates have more than doubled from their year-ago level. This has led to a sharp drop in sales. This decline in sales has only had a limited effect on sale prices to date, but with inventories of unsold homes rising rapidly, it seems inevitable that prices will soon decline.
There is likely to be a spillover from the sale market to the rental market. Many of the houses that go unsold are likely to end up as rentals. An increased supply of rental units will put downward pressure on rents.
We are seeing some evidence of slower rental inflation in some private indexes, but this process will take time to work through. This will definitely help low and moderate-income households, but the good news is that the Fed has pretty much done its work in this area.
With mortgage rates now over 6.0 percent, it is not clear that pushing rates still higher will have much additional impact on the housing market. We are likely to see some improvement in the rental market over the next six months to a year.
However, getting prices down to more affordable levels is a longer-term story that depends on more construction. In this area, Fed rate hikes are a clear negative. Housing starts are already down by double-digit levels against their year-ago pace. Further hikes are likely to slow construction even more. That is not a good story for housing affordability.
Fed Rate Hikes Are Bad News at the Bottom
To sum up the story, we know with absolute certainty that Fed rate hikes will disproportionately hit lower-paid workers. They are both the ones most likely to lose their jobs and the ones to see the biggest impact on wage growth.
Insofar as lower-income families are seeing the biggest hit from inflation, due to rising prices in necessities, Fed policy is likely to be of limited help. The rate hikes have slowed inflation in the housing sector, which is huge, but it is not clear that further hikes will provide much benefit in the form of lower rents for moderate-income households. In short, it is hard to make the case that Fed rate hikes will somehow help lower-income households.
We all understand the Fed’s responsibility for preventing inflation from spiraling to dangerous levels. There can be reasonable differences on the extent of this threat currently, but we should be clear on the trade-offs involved in Fed policy. Those at the bottom end of the income distribution will be paying the biggest price for the Fed’s anti-inflation policy, and it is important to recognize this fact.