As inflation in the United States reaches new heights, economists are debating how high the Federal Reserve will need to hike interest rates to curb demand and rein in price growth. Some commentators believe that the Fed will need to be as aggressive as Fed Chair Paul Volcker in the early 1980s, who ended up raising interest rates to as high as 20%.
Such figures understandably raise concerns that the effort to contain inflation will result in a recession and a sharp increase in unemployment. As a recent Peterson Institute for International Economics policy brief observes, reductions in job vacancies engineered through contractionary policies empirically go hand in hand with increases in unemployment.
Worse, while interest-rate hikes would likely increase unemployment over time, they will be insufficient to rein in inflation in the short run. Recent price increases may have been triggered by extraordinarily high demand following the pandemic, but supply-side factors -- especially labour shortages and the energy crisis caused by Russia's war in Ukraine -- have also played a significant role. Inflation cannot be contained unless these factors are addressed, too.
