• The Fed has said cooling inflation will likely involve a rise in unemployment as the labor market softens.
  • Higher unemployment, however, is the "first and foremost" risk to the economy, Goldman Sachs said.
  • Letting the US lose jobs is "pure waste," while inflation is simply "redistribution," another economist said.

It's joblessness, not inflation, that poses the biggest threat to the economic recovery, according to several top US economists.

Policymakers are walking an economic tightrope. The Federal Reserve and Congress highlight inflation as the biggest threat to the economy, and the central bank has aggressively raised interest rates in hopes of slowing price growth. Fed Chair Jerome Powell has frequently pointed to the labor market's strength as a sign that the economy can shoulder the burden of higher rates.

He reiterated his cautious optimism on Wednesday, saying the Fed sees "a path for us to be able to bring inflation down while sustaining a strong labor market." Yet cooling the price surge is also likely to involve "some softening in labor market conditions," Powell added.

Critics, however, fear the Fed is sacrificing employment to pull inflation lower. That tradeoff, even if effective, could do more harm than good. The financial cushion from stimulus and boosted saving has worn away for most Americans, and most are tapping their savings to keep spending and driving the recovery forward.

Higher unemployment, then, is the "first and foremost" risk to the recovery, as it could dramatically slow growth, Jason English, a lead analyst at Goldman Sachs, said in a Monday webinar.

"There is a propensity to spend that exists, a momentum behind it," he said, adding that strong wage growth staved off some of the long-term damage from higher prices.

Higher unemployment would likely pull the economy into a recession, as jobless Americans would pull back on spending, corporate revenues would shrink, and firms would lay workers off to cut costs. That would have a far more dramatic effect on economy-wide incomes than inflation, Josh Bivens, the director of research at the Economic Policy Institute, said in a July blog post

Going too far with labor-market softening "represents pure waste," as it leaves the economy producing less than its potential, he said. Higher inflation, meanwhile, "is pure redistribution in the short run," and doesn't reduce overall wealth.

"One person's cost is another person's income," Bivens added.

It's not just economists who view unemployment as the bigger menace; the typical worker does, too. A 2020 paper from three economists based in New Zealand found that households polled from 2005 to 2019 feel much more pain from unemployment than inflation. Increases in unemployment were about six times as powerful at lowering people's economic moods compared to increases in inflation, according to the paper. Respondents were also nine to 13 times more likely to cite sadness or physical pain from a one-percentage-point jump in unemployment than they were from a similar jump in headline inflation.

The fallout from a recession and high unemployment is simply much worse than high inflation, Claudia Sahm, a former Federal Reserve and White House economist, said in a July newsletter. Startups and small businesses face a serious risk of closing down. State and local governments are more likely to slash jobs as tax revenues shrink. The low earners who recover slowest from downturns are also the most likely to take the brunt of the economic hit in the next one, meaning a near-term recession would deal a painful one-two punch to disadvantaged Americans.

Aggressively raising interest rates and cooling the labor market is one way to fight price growth, but it's "medicine that's worse than the disease," Sahm said.

"A lost paycheck would be a much bigger problem than covering the extra costs of inflation now. And it's the workers at the bottom who are the most likely to lose their jobs," Sahm said. "We need many things today, but a recession ain't one of them."

Read the original article on Business Insider