Will Your Job Be a Victim of the Fed’s War on Inflation?

Fed rate hikes could cause layoffs—and might not tackle inflation at its source

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TheBalance / Alice Morgan

With prices for gas and other necessities of life soaring, there’s no doubt inflation is bad. But could the Federal Reserve’s cure turn out to be worse than the disease?

As the Fed’s campaign to fight inflation intensifies with the biggest interest rate hikes since 1994, skeptics who include lawmakers and economists are questioning whether getting price increases under control this way is worth a potential cost of millions of lost jobs—and whether it will even work.

Some dissenters believe the Fed’s approach, which is to intentionally slow the economy, is misguided and risks snuffing out one of the economy’s few bright spots—the great job market, where there are nearly two open positions for every unemployed job seeker.

As Massachusetts senator Elizabeth Warren put it, questioning Fed chair Jerome Powell at a hearing in June, “You know what’s worse than high inflation and low unemployment? It’s high inflation and a recession with millions of people out of work.”

Key Takeaways

  • The Federal Reserve is combating soaring inflation by raising its benchmark interest rate, increasing borrowing costs and discouraging spending.
  • The interest rate hikes come with a major downside: Slowing the economy harms the job market and could cause a recession.
  • The last time we saw inflation like this, in the early 1980s, the Fed hiked rates so much that it caused a recession and massive job losses.
  • Some skeptics think raising rates is the wrong approach and could hurt workers while leaving the source of today’s inflation—supply chain problems—unchanged.

Why the Fed Is Raising Rates

The U.S. central bank, the Federal Reserve, is in the midst of a series of interest-rate hikes that are designed to cool today’s rampant price increases by raising borrowing costs for all kinds of loans, including credit cards, car loans, and even, indirectly, mortgages. The Fed’s benchmark interest rate (the federal funds rate) had been held down to near-zero during the COVID-19 pandemic to stimulate the economy, and jacking it up is meant to do the opposite.

The thinking is that prices are rapidly rising because of an imbalance in supply and demand: Businesses just can’t deliver all the goods and services their customers want, so prices rise. The Fed can’t increase the supply of anything, but by reducing households’ and businesses’ buying power, it will stifle some of the demand, allowing balance to return—and inflation to fall.

Ordinary people’s finances are collateral damage in this battle, said James K. Galbraith, a professor of economics at the University of Texas. “People are being squeezed on their energy bill,” Galbraith said. “And now the Fed says, ‘Oh gee, we’ll come along and help by squeezing you on your credit cards and on your mortgages and on your car loans and on everything else that is tied to the interest rate that we control.’ ”

A Soft-Ish Landing

Other economists think the Fed’s strategy is a possibly painful but necessary corrective to an overheating economy, and that slower economic growth for a while is worth it to vanquish inflation. Officials at the Fed are optimistic they can tap the brakes on the economy without bringing it to a screeching halt and causing a recession.

Fed officials say their goal is not to send the economy crashing to the bottom of a cliff, but rather to bring it in for a “soft” or “soft-ish” landing in which price increases slow down to an acceptable level without the economy going into a recession. But the Fed’s own projections predict that workers will pay a price for lowering inflation, with the unemployment rate rising to 4.1% by 2024 from its current, near-historic-low level of 3.6%. That means some 822,000 more jobless people than there are now.

“We don't seek to put people out of work,” Fed Chair Jerome Powell said at a press conference last month. “Of course, we never think too many people are working and fewer people need to have jobs. But we also think that you really cannot have the kind of labor market we want without price stability.”

In the long run, the Fed’s dual goals of price stability (low inflation) and high employment should go hand in hand. When prices are stable, it’s easier for businesses to plan, invest, and hire, which helps the economy grow and is good for the job market. But controlling high inflation by raising interest rates—even by comparatively small increments—could mean sacrificing jobs in the short run.

Eroding Workers’ Power

Taking away demand for goods and services ultimately means that even if there aren’t mass layoffs, the power of workers in the labor market to negotiate better pay and working conditions would be diminished. That’s why some economists see the Fed’s actions as hostile to working people who have been unionizing and demanding improved working conditions.

“Higher interest rates and the consequent increase in unemployment are clearly a way to discipline workers,” Servaas Storm, a professor of economics at Delft University of Technology in the Netherlands, wrote in an email. “The interest-rate hike will hurt workers who are going to lose their jobs.”

Powell said one of his goals is to rein in the wage increases workers have been getting, for fear that those wage hikes could force companies to raise prices. However, those increases have not kept up with inflation. That means they’re not contributing to inflation, and the Fed’s fear of wage increases is misguided, said Storm, who has carried out research on the Fed's interest rate moves. In fact, wage growth has been slow enough that it’s actually hindering inflation, not increasing it, according to a recent analysis by Josh Bivens, director of research at the progressive Economic Policy Institute think tank.

Overall, the rate increases are likely to tip the scales of the labor market in favor of employers. One goal is to boost the labor force participation rate, which shows the percentage of people seeking work or working. It has been significantly reduced since the pandemic hit and has been slow to recover. Financial pressure from those rate increases might force some people currently on the sidelines back into low-paid jobs under bad conditions they’d rather avoid, Galbraith said.

“Employers want them in more vulnerable positions,” he said.

The Inflation Hawks

But for all the criticism it’s received for going too far, the Fed also faces critics who think it should go much further, fast. According to one school of thought, what the economy needs right now is not the Fed’s targeted slight slowdown with 4.1% unemployment, but for millions more people to lose their jobs.

That’s the point of view of former Treasury secretary Lawrence Summers and other economists in the “inflation hawk” camp, who believe the Fed has no choice but to smother the economy with fast, aggressive interest-rate hikes. Curbing inflation requires an unemployment rate of at least 5% for five years, or a one-year shock of 10% unemployment, Summers said in a speech in London last month, according to a report by Bloomberg.

That version would mean more than 10 million additional people out of work compared to today. And while Summers’ 5% unemployment prescription is not far off the 4.5% average unemployment rate of the three decades preceding the pandemic, that would still mean 2.3 million more people being out of work each year than are today when unemployment is around 3.6%.

In arguing for drastic measures, Summers points to a historical precedent: the double-digit inflation of the late 1970s and early 1980s, which only went away after Fed chair Paul Volcker jacked up the Fed’s benchmark interest rate to 20% in 1980 and kept it over 10% for years. (The Fed’s measures so far have been much tamer—the rate is still less than 2% today, even after the latest round of rate increases.) While many factors are different today, the Fed is facing the same problem—rampant inflation—with the same tool available for controlling it.

The 1980s rate hikes brought not a soft landing for workers, but a harsh recession. Employment soared to double digits, the highest in modern records before the pandemic. Industries including steel and car manufacturing were decimated, and an entire swath of the country—the stronghold of organized labor—was turned into a “rust belt” of abandoned factories, with consequences felt to this day.

“Employment relations were restructured to the disadvantage of workers, as workplaces became fissured, employment protection was diminished, and workers were denied the right to join unions,” Storm said.

While Summers may not have much company in calling for an extremely aggressive Volcker-like response from the Fed, he’s hardly the only economist who thinks reining in inflation will require unemployment to rise at least somewhat. Many believe the Fed waited too long to begin using rate increases—the only major tool at its disposal—to fight inflation, and is now playing much-needed catch-up.

Rising Wages Aren’t the Problem

Some question whether any action by the Fed is capable of fixing a modern inflation problem that’s very different from its 1970s incarnation. Back then, a heavily unionized workforce was able to demand wages that kept up with or even exceeded price increases, said Galbraith, who, as a congressional staffer in the 1980s, helped craft legislation that mandated that the Fed’s role is not only to preserve price stability, but also to ensure maximum employment.

Today’s inflation is not caused by wages, he said. Instead, price increases are mainly driven by factors well outside of the Fed’s control: disruptions to the supply chain caused by the pandemic, and food and energy prices driven upward by the Russian invasion of Ukraine. So the Fed’s interest-rate hikes are not attacking the problem at its source, and only adding to financial problems experienced by consumers, according to Galbraith.

Alternative Solutions

Galbraith and Storm said there are other ways to mitigate inflation that wouldn’t hurt workers. Storm suggested that temporary price controls on food and energy, while controversial, could prove effective. (Price controls were tried in the 1970s and failed, but Storm said that such measures have been effective in emergencies.)

Storm also proposed a less-divisive remedy, which would involve helping workers who dropped out of the labor force—especially the truckers who are all-important to restoring supply lines—get back to work by supporting them with health care and child care. Providing vulnerable people fiscal support such as the inflation relief checks now being sent out in multiple states could also help lessen inflation’s blow on low-income households.

Because such a large part of the price increases is due to energy costs, Galbraith supports price controls targeted at oil, and taxes on profits engineered in such a way as to encourage energy companies to ramp up production. However, Galbraith isn’t optimistic about the government trying these approaches, and predicted ordinary households will once again pay the price.

“What we're seeing now is a squeeze on working people,” Galbraith said. “It’s hitting them in their household costs, hitting them in their interest costs, and the next thing will be hitting them on their employment prospects—the ability to find and hold jobs on their own terms that they find acceptable.”

Shore Up Your Finances

While there’s nothing you can do about monetary policy, you can begin to prepare for a  downturn and job losses in case the worst predictions come true. That’s what many Americans are doing, according to a poll this week by MagnifyMoney, a personal finance publication owned by LendingTree.

Among the 2,000 consumers surveyed, 89% had taken at least one step to prepare for a possible recession, with the most common step being cutting down on spending. Other steps they’re taking that you can do, too, include sticking to a budget, building an emergency fund, paying down debt, and working a side gig.

Have a question, comment, or story to share? You can reach Diccon at dhyatt@thebalance.com.

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