The U.S. economy is sending complicated and sometimes conflicting signals right now. But in some ways, the situation is simple: Americans are earning and spending more money than ever, but prices are rising even faster.
U.S. households took in $4.6 trillion in after-tax income in the second quarter, 1.6 percent more than in the first three months of the year. But consumer prices rose 1.7 percent, meaning that incomes, adjusted for inflation, actually fell.
It was a similar story across the economy. Businesses invested more in absolute dollars, but cut back once inflation is taken into account. Consumer spending did rise faster than prices, but barely. And total economic output, adjusted for inflation, fell for the second straight quarter, despite accelerating without adjustment.
That dynamic helps explain why the Federal Reserve is moving so aggressively to raise interest rates and slow the economy down. Inflation reflects, in part, that demand — for goods, services, equipment, workers — outstrips supply. By raising the cost of borrowing money, the Fed hopes to bring down demand, and with it, inflation.
There are signs that is already happening. The housing market slowed markedly in the second quarter, and business investment has also stalled; those sectors are among the most sensitive to rising interest rates.
But inflation isn’t merely a result of domestic forces. Oil prices rose sharply this year after Russia’s invasion of Ukraine. China’s efforts to contain the spread of the coronavirus have added to supply-chain disruptions. The Fed can’t control those dynamics. Nor can it do anything to bring workers back to the job market or otherwise help the supply side of the domestic economy.
The risk is that, in trying to control inflation, the Fed will slow demand so much that companies start laying off workers, unemployment rises sharply and the economy falls into a recession. Jerome H. Powell, the Fed chair, acknowledged that risk on Wednesday, saying that the path to avoiding a recession had “narrowed” even as he expressed hope that a downturn could still be avoided.
“We’re not trying to have a recession and we don’t think we have to,” he said. “We think there’s a path for us to be able to bring inflation down while sustaining a strong labor market.”
