This paper uses historical labor market data to assess the plausibility that the Federal Reserve can engineer a soft landing for the economy. We first show that the labor market today is significantly tighter than implied by the unemployment rate: the vacancy and quit rates currently experienced in the United States correspond to a degree of labor market tightness previously associated with sub-2 percent unemployment rates. We highlight that the super-tight labor market coincides with current wage inflation of 6.5 percent – the highest level experienced in the past 40 years – and that firm-side slack measures predict further increases in wage inflation over the coming year. Finally, we show that high levels of wage inflation have historically been associated with a substantial risk of a recession over the next one to two years. We argue that periods that historically have been hailed as successful soft landings have little in common with the present moment. Our results suggest a very low likelihood that the Federal Reserve can reduce inflation without causing a significant slowdown in economic activity.

Since the outset of the Covid-19 pandemic, labor market indicators that traditionally move together have been sending different signals about the degree of slack in the U.S. labor market.While some indicators on the supply-side, such as the prime-age employment-to-population ratio, suggest that there is still some slack in the labor market, other indicators on the demand-side, such as the job vacancy rate and the quits rate, imply that the labor market is already very tight.In light of these divergent signals, this paper compares alternative labor market indicators as predictors of wage inflation.Using national time series and state cross-section data, we find (i) unemployment is a better predictor of wage inflation than non-employment and (ii) vacancy rates and quit rates have substantial predictive power for wage inflation.We highlight the fact that vacancy and quit rates currently experienced in the United States correspond to a degree of labor market tightness previously associated with sub-2 percent unemployment rates.Finally, we show that predicted firm-side unemployment has dominant explanatory power with respect to subsequent inflation.Our results, along with a cursory analysis of labor force participation information, suggest that labor market tightness is likely to contribute significantly to inflationary pressure in the United States for some time to come.

The Federal Reserve seeks to cool an overheated US labor market to ease wage hikes and reduce job vacancies, without a painful spike in unemployment. But empirical evidence indicates that these goals have never been accomplished together and remain unlikely now. In fact, fighting inflation will require a reduction in job vacancies and also an increase in unemployment. The inverse relationship between job vacancies and unemployment is measured by the Beveridge curve, named after a British economist. Blanchard, Domash, and Summers find that the Fed’s hope that vacancies can be decreased without increasing unemployment flies in the face of historical empirical evidence. The current low unemployment rate and the very high vacancy-to-unemployment ratio suggest that the labor market is overheating and the natural unemployment rate has increased. It has increased about 1.3 percentage points from its pre-COVID level, implying the labor market is even more overheated than suggested by the current unemployment rate.