Unemployment in the U.S. could climb to as high as 5% in 2023 from the current rate of 3.7% in response to a series of interest-rate hikes engineered by the Federal Reserve to combat high inflation, a senior central bank official said Monday.
John Williams, president of the New York Fed, signaled in a speech that the economy was going to get even weaker than the central bank had previously estimated. Just two months ago, the Fed had forecast the unemployment rate would top out around 4.4%.
“We are already seeing some of the effects of tighter monetary policy,” Williams said in a virtual speech to the Economics Club of New York. “As this continues, I expect real [gross domestic product] to increase only modestly this year and in 2023.”
The Fed is trying to roll back the biggest increase in U.S. inflation in four decades. The annual increase in prices jumped to as high as 9.1% last summer before tapering off to 7.7% as of October, according to the most recent consumer price index.
Saying the rate of price increases is “far too high,” Williams predicted inflation would slow to 5% to 5.5% by the end of this year and continue to decline to 3% to 3.5% in 2023. That’s a bit higher than the Fed’s most recent forecast.
He noted the big surge in commodity prices over the past two years has begun to subside. Supply bottlenecks that limited how much businesses could produce have also eased. Those were two of the biggest contributors to the surge in inflation.
Getting inflation back down to the Fed’s 2% target, however, is likely to take longer, Williams said. He pointed out that demand for labor and services — the biggest part of the economy — were still too strong and keeping upward pressure on inflation.
“But further tightening of monetary policy should help restore balance between demand and supply and bring inflation back to 2% over the next few years,” he said.
Inflation averaged less than 2% a year in the decade preceding the pandemic.
Williams is seen as a close ally of Fed Chairman Jerome Powell. He did not give an indication of how much the Fed should raise interest rates at its next big meeting in December.
Wall Street increasingly believes the Fed will deliver a 1/2-point rate hike after three straight increases of 75 basis points.
The Fed has raised a key short-term interest rate to a top end of 4% from near zero in the spring. The rate is likely to rise to around 5%, analysts believe, before the central bank pauses to determine its next steps.
The cost of borrowing is tied closely to the so-called fed funds rate. The rate on a 30-year fixed mortgage, for example, has soared to as high as 7% from less than 3% a year ago and put a damper on home sales. Other consumer and business loans have also become more expensive.
Higher rates typically slow the economy and can sometimes trigger a recession. Historically an increase in the unemployment rate by as much as Williams forecasts is followed by a recession.
What’s more, the Fed’s economic staff for the first time said a recession was possible in the next year, according to a detailed summary of the bank’s last strategy session in early November. The bank’s previous minutes have not mentioned the possibility of a recession.