Will Slaying Inflation Require Recession?

Episode Summary

Executive Summary: The episode examines whether the Fed can curb inflation by cooling an overheated labor market without triggering a recession. Olivier Blanchard argues that falling vacancies will inevitably be followed by higher unemployment, likely pushing unemployment to 6%-7% and requiring recession-like growth loss. Jan Hatzius is more optimistic, seeing temporary inflation pressures easing, labor rebalancing underway, and a plausible soft landing with unemployment near 4.2% by end-2024.

Main Topics: Fed tightening and the inflation fight (Priority: 5/5): The discussion frames the Fed’s aggressive rate hikes as necessary to combat still-elevated inflation, while asking how much damage to growth will be required to restore price stability. Labor market overheating and job openings (Priority: 5/5): A key focus is the unusually large gap between job openings and available workers, viewed as evidence of an overheated labor market that must rebalance for inflation to fall. Blanchard’s case for higher unemployment (Priority: 5/5): Blanchard argues vacancy declines historically lead to unemployment increases, and that firms responding to weaker demand will both slow hiring and lay off workers. Hatzius’s soft-landing thesis (Priority: 5/5): Hatzius contends the post-pandemic surge in vacancies can unwind mainly through reduced openings rather than a large jump in unemployment, aided by slowing demand and improving supply. Inflation drivers beyond labor tightness (Priority: 4/5): The speakers debate how much inflation is explained by labor-market mismatch versus commodity prices, energy, expectations, rents, and wages, and whether these pressures are temporary. Recession risk and policy timing (Priority: 4/5): The conversation explores whether a slower path to disinflation could avoid recession, or whether credibility and the scale of adjustment will force a downturn.

Key Arguments: Blanchard says vacancies have never declined without unemployment rising later, and basic firm behavior under weaker demand implies both reduced hiring and layoffs. Blanchard believes the labor market’s natural rate has risen due to matching frictions, meaning unemployment must rise just to reach equilibrium before disinflation can be achieved. Blanchard argues commodity and energy shocks, plus inflation expectations, can reinforce wage-price pressures and require even higher unemployment to bring inflation back to target. Hatzius argues 2021 was an exceptionally distorted year: rapid GDP growth, pandemic labor-supply constraints, supply-chain problems, and firms over-posting vacancies. Hatzius says current demand slowing, improving supply, declining quits, and decelerating employment growth show labor-market rebalancing is underway without a severe rise in unemployment. Hatzius argues much of inflation was temporary and is already easing through goods disinflation, lower energy pressures, dollar appreciation, and eventual normalization in rents and services. Hatzius maintains a soft landing is more plausible if growth stays below trend for longer and inflation keeps trending down, even if not all the way to 2% immediately.

Data Points: Job openings rate decline: 0.4 percentage point - Hatzius says this is the largest decline outside a recession. Unemployment rate: 3.7% - Current unemployment rate referenced by Blanchard as below the implied natural rate. Blanchard implied natural rate: 4.5%-4.55% - His estimate of the unemployment rate needed to match labor supply and demand more normally. Potential unemployment peak: 6%-7% - Blanchard’s median forecast range for the unemployment rate needed to tame inflation. Current unemployment forecast: 4.2% by end-2024 - Hatzius’s forecast for unemployment in a soft-landing scenario. Recession probability: 30% over 12 months; nearly 50% over 24 months - Hatzius’s stated recession probabilities. Growth pace: ~1% - Hatzius describes current growth as modestly positive but below trend. Growth slowdown needed to raise unemployment 1.3 points: ~3% below normal growth - Blanchard uses a Hawkins coefficient-style rule of thumb. U.S. 2021 GDP growth relative to potential: Fastest in at least four decades - Hatzius cites this as evidence of an unusually tight post-pandemic environment. Job openings vs unemployment pattern: No prior exception cited - Blanchard says openings have always fallen before unemployment rises in past turnarounds.

Pivotal Quotes: "There seems to be a hope of some immaculate conception outcome in which basically job openings decreased and unemployment doesn't increase. It will not happen." — Olivier Blanchard: Blanchard rejects the idea that the labor market can cool without higher unemployment. "I think we're on a path that is certainly consistent with the idea that we're going to be able to bring down job openings without a massive increase in the unemployment rate." — Jan Hatzius: Hatzius outlines his soft-landing view of labor-market rebalancing. "I wish. My answer is I wish. But the answer is no." — Olivier Blanchard: Blanchard on whether inflation can be tamed without a meaningful rise in unemployment.

Implications: The debate centers on whether the Fed can engineer a soft landing. If Blanchard is right, recession and materially higher unemployment may be unavoidable; if Hatzius is right, inflation can ease as supply normalizes and vacancies fall, limiting economic damage.