Axios Macro

Fed chair Jerome Powell warned that bringing down inflation will require economic pain for households. But how much pain? That critical question determines what the job market looks like in the years ahead.

Why it matters: When central banks work to lower inflation, they do so at a cost: slower growth and a cooler labor market. Economists are trying to work out just how big of a blow is ahead for the economy as the Fed tries to bring down scorching inflation.

Enter the "sacrifice ratio," a wonky estimate of the economic growth and employment that will need to be "sacrificed" in order for inflation to come down. 

• In other words: For each percentage point reduction in inflation, how much excess unemployment is necessary? 

Where it stands: The labor market is humming, with unemployment at the lowest level in a half-century. But the Fed's efforts to squash inflation — which officials suggest is far from over — will eventually come at the expense of the solid labor market.

One factor working in the Fed's favor: "Supply chain disruptions are easing, so that will be a tailwind," Tuan Nguyen, an economist at accounting firm RSM, tells Axios.

• "About one-third of inflation was caused by supply chain disruption," he estimates. "Historically, it's been all about demand."

That's something RSM takes into account in its own estimate of how many jobs the economy will have to shed to tame prices.

• The firm said this week that for inflation to fall to more acceptable levels within the next few years — as close as possible to the Fed's 2% target — unemployment would need to spike to a minimum of 4.6%, or as high as 6.7%. That translates to a loss of between 1.7 million and 5.3 million jobs, RSM estimated.
• That wide range depends on a lot of unknowable variables, including at what point the Fed will declare victory.

By contrast, former Treasury Secretary Larry Summers has argued that it will take unemployment of 5% for five years to contain inflation.

Yes, but: It's possible that historical bouts of inflation might understate how much pain central bankers will have to inflict on the economy now to put a lid on prices. 

• "Central banks are likely to face a higher sacrifice ratio compared with the 1980s, even if prices were to respond more strongly to changes in domestic economic conditions, as the globalisation of inflation makes it more difficult for central banks to control price pressures," Isabel Schnabel, a top European Central Bank official, said in a speech on Saturday.

What they're saying: "No recessions or disinflationary episodes are exactly the same. It's not as if the past is going to foretell the future with great accuracy," says Vikram Kumar, an economics professor at Davidson College.

One of the great mysteries of the economy this year has been the combination of blockbuster jobs growth during a time of very low unemployment and complaints of a labor shortage.

• For months, it has seemed like something has to give, but new evidence suggests that "something" may have arrived.

Driving the news: ADP, the nation's largest payroll processor, debuted its new indicator of private-sector payrolls. It extrapolates data based on workers added or cut, and paychecks sent, by its own massive client base.

• It showed private employers adding 132,000 jobs in August — a downshift from 270,000 in July, and the lowest reading since January 2021.
• If official government employment data for August due out Friday shows a similar deceleration, it would support the idea that the era of big-time job growth is ending. Both the Fed and the Biden administration have indicated that would be a welcome shift.

What they're saying: "We could be at an inflection point, from super-charged job gains to something more normal," said Nela Richardson, ADP's chief economist, in a statement accompanying the release.

• The newly designed ADP report aims to capture underlying employment trends, in contrast to an older version that tried to predict what the Bureau of Labor Statistics would report two days later.

Go deeper: Our colleague Felix Salmon previewed the new indicator here.