Why Bank of America Says We Need Higher Unemployment to Stop Spiraling Costs

Understand the connection between unemployment and inflation with our quick explainer.

Nine in 10 Americans who voted in the midterms said inflation played a significant part in their decision, according to data from The Wall Street Journal. People are understandably worried about spiraling prices. Unfortunately, if a recent note from Bank of America is correct, the only way inflation can come down is if unemployment goes up. Or to put it another way, the country can't address cost of living issues without also causing job losses.

The connection between inflation and the job market

According to an Insider article, Bank of America analysts think the U.S. economy is overheating, particularly in terms of the labor market. The note said the Federal Reserve would need to "engineer about a 2% rise in the unemployment rate" if it's to get inflation under control.

Bank of America is not alone in arguing that unemployment is an inevitable consequence of the Fed's actions. Olivier Blanchard, former chief economist at the International Monetary Fund told a Goldman Sachs newsletter, "I have little doubt that unemployment will increase as the Fed takes further steps to cool the economy."

Without getting too deep into economic theories, the thinking on wages is that we're in a vicious circle. Unemployment is lower than the number of job openings. As a result, companies offer higher salaries so they can fill vacant positions. Existing employees also want more money due to the higher cost of living. The increase in wages means higher costs for businesses, which can result in higher prices and contribute to more inflation.

Bank of America says, "The Fed has to do the dirty work of bringing labor demand down and in line with labor supply." The trouble is that the Fed doesn't directly influence employment rates. One of the main tools at its disposal is to raise interest rates, which it's been doing pretty aggressively. Interest rates only indirectly affect employment.

Raising rates makes it more expensive for people to borrow. In theory, this lowers demand and slows the economy. If people spend less, sales will decline, and businesses will stop hiring. If the economy slows even further, companies could have to lay people off.

Unfortunately, so far inflation remains stubbornly high. The Fed has already raised rates by an unprecedented 0.75% four times in a row. Some economists argue that inflation isn't budging because high wages are only part of the problem. They suggest that it's other factors, such as supply chain issues and a global energy crisis, that are driving prices upwards. The difficulty is that these won't be impacted by interest rate hikes.

How to prepare for job losses

We don't know what will happen next year. Some economists think job losses are not an inevitable consequence of economic slowdown. It's certainly true that unemployment remains low and job openings are still relatively high. All the same, it's worth taking steps to protect your career and your finances.

The most important thing you can do is to make a plan and know how you'll deal with job loss if it happens. If you're already thinking about changing careers, what skills might you need to make the switch? If you want to stay in your current field, what steps might you take if you do get laid off? Who might you call, and what means might you use to look for another position?

Here are a few things you can do today:

• Make sure your emergency fund is well stocked. If you have three to six months' worth of living expenses in a separate savings account, you'll be better prepared to handle any financial emergency that comes your way. If you're particularly worried, you might aim to put even more cash into your emergency fund. That cash will give you more time to find work in the event that you lose your job.
• Update your resume. If you do get laid off, you may not be in the best frame of mind to breathe new life into your resume. Do it now instead. It's also good to update your profile on sites like LinkedIn and reach out to your professional network.
• Look for extra training opportunities. Learning new skills is good for your career in a number of ways. It can energize you in your current role and help you work more effectively. It can also show a new employer that you're willing to learn. Online or in-person courses can teach you a lot. You can also keep up to date through industry newsletters and books.

There's a lot of uncertainty right now, which is stressful at the best of times. Even more so when spiraling costs stretch our budgets to breaking point. Try to position yourself as best you can to weather the storm and know that it won't last forever. Economic cycles involve both growth and contraction, so hold on to the fact that this too shall pass.