A crowd of people move through various areas of the recently revamped Penn Station. The proportion of individuals in their prime working ages—those between 25 and 54—who are either employed or actively seeking employment has reached its highest level in two decades.

The surge in inflation witnessed last year, the highest in four decades, was already a painful experience for American households. However, the expected solution, which was raising interest rates substantially to reduce spending and hiring, was thought to make things even more difficult.

Gloomy forecasts from economists had foreseen that as the Federal Reserve continued to raise its benchmark interest rate, consumers and businesses would slow down on spending. Companies would cut jobs, and unemployment could surge as high as 7% or more—twice its level when the Fed initiated its credit-tightening measures. 

Yet, much to the relief of many, the reality thus far has been quite different. As interest rates have increased, inflation has declined from its peak of 9.1% in June 2022 to 3.7%. However, the unemployment rate, still at a relatively low 3.8%, has barely moved since March 2022, when the Fed embarked on an unusually rapid series of 11 rate hikes.

If these trends continues, the central bank might achieve a rare and challenging “soft landing”—controlling inflation without sliding into a severe economic downturn. This would be a stark contrast to the last inflation surge in the 1970s and early 1980s when former Federal Reserve Chair Paul Volcker decisively increased the central bank’s primary short-term interest rate to more than 19%, it led to a surge in unemployment, reaching 10.8%, which represented the highest level since World War II at that particular moment.

A year ago, Federal Reserve Chair Jerome Powell made a significant announcement, saying that the Fed was ready to take forceful actions like Volcker did in the past, anticipating that increasing interest rates might result in increased unemployment, which he referred to as “pain.” Powell even mentioned the title of Volcker’s autobiography, “Keeping At It,” to emphasize the Fed’s determination.

Over time, as the job market has displayed surprising resilience, Powell has adopted a more optimistic tone. During a recent news conference, he suggested that a soft landing remains a “feasible.” outcome, if not guaranteed.

“That’s really what we’ve been seeing,” he noted. “Progress without higher unemployment, for now.”

How did the Federal Reserve’s interest rate increases effectively bring down inflation without causing severe repercussions? Can the job market and the economy sustain their robustness with the Fed’s intention to maintain elevated borrowing rates well into 2024?

Here are some factors contributing to the economy’s unexpected resilience and an examination of whether it can endure:

The usual idea that beating high inflation requires a lot of people losing their jobs might not be true after the pandemic. Claudia Sahm, a former Fed economist, suggested that those who thought high unemployment was necessary to control inflation believed it was caused by people buying too much. But to control this kind of inflation, the Fed would have to make people spend less, which would hurt businesses and jobs. However, inflation has gone down even though people kept spending on shopping, travel, and entertainment.

Alan Detmeister, another former Fed economist, thinks this was caused by other reasons. Many economists now believe that supply disruptions from the pandemic and Russia’s invasion of Ukraine had a bigger role in causing inflation. Even though people spent more on goods, they spent less on services, so overall demand stayed close to what it was before the pandemic.

This situation might be more like what happened after World War II than what happened in the late 1970s and early 1980s. After World War II, factories slowed down, but people moving to suburban areas and purchasing homes and appliances balanced things out, and inflation decreased once production picked up again.

A recent study by Mike Konczal illustrated that prices of services and most goods have gone down as more of them became available. This suggests that having an abundance of supplies has been the main reason inflation has gone down, except for food and gas prices, which can be unstable.

We’re not sure if this trend of slowing inflation will continue. Susan Collins, the president of the Federal Reserve Bank of Boston, said that although increased supplies have contributed to lowering inflation in goods, there is still a need for additional improvements in services to reach the Federal Reserve’s 2% inflation target.

Konczal is hopeful, though. He sees inflation going down in many service areas, like restaurants and laundry services, even without a big drop in demand. His study suggests that this trend of lower inflation could continue.

Changes in the Job Market:

Another reason things are getting better is because of changes in the job market, especially in the number of people seeking work. Since the Fed started raising interest rates, about 3.4 million people have started looking for jobs again. This is partly because more immigrants are coming in after the pandemic restrictions were lifted.

At the same time, more people are coming back to the job market. The number of adults aged 25-54 who are either working or looking for a job is at its highest in 20 years.

But businesses seem to need fewer workers. Instead of getting rid of jobs, they’re just not hiring as many new people. Currently, job openings have decreased compared to the previous year, although they remain higher than pre-pandemic levels. Additionally, there is a reduced number of individuals resigning from their jobs in pursuit of higher-paying opportunities.

This means that the job market has become better balanced, with fewer job openings and more people looking for work. This takes the pressure off companies to raise wages a lot to attract and keep workers. And even with inflation slowing down, wages are now growing faster than prices.

Even companies concerned about the state of the economy are showing a decreased inclination to terminate their workforce. Numerous employers are reluctant to undergo the recruitment and training process for new employees once again.

Resilient Consumer and Business Activity:

Another reason why higher interest rates haven’t caused higher unemployment rates is that many households and companies are better prepared this time. Americans saved a lot of the money they got from stimulus checks and unemployment benefits during the pandemic. This helped them keep spending, even this year. But we’re not sure how long these savings will last, and some people are starting to use their credit cards more.

Businesses, especially larges ones, used lower interest rates in 2020 and 2021 to lower their debt payments. So, when interest rates went up, it didn’t make their borrowing costs go up by a lot. But over time, they’ll have to pay higher rates when they refinance their debt, which could hurt their profits and lead to job cuts.

Right now, some businesses are benefiting from government help, like investments in infrastructure and renewable energy. They’re spending more on new factories because of this.

In summary, the Federal Reserve’s projections show that core inflation (excluding energy and food) is expected to go down to 2.6% by the end of 2024 from the current 4.2%, according to the Fed’s preferred measurement. At the same time, they think unemployment will go up to just 4.1%, which is lower than what they thought in June, when they estimated 4.5% for 2024.

William English, a former Fed official and now a professor at Yale School of Management, said, “If we can achieve this outcome without a recession, it’s a good result considering how big the shock was.”