A Dubious Miracle

For the past two decades the Federal Reserve has been an engine of inequality. Its policies and long-term strategy have steadily generated greater disparities of wealth and income. It was not the only engine, of course, and certainly did not set out deliberately to achieve the growing inequalities, but that was the ineluctable result. The campaign began in 1979, when runaway inflation engulfed the economy. Fed Chairman Paul Volcker induced a long, harsh recession to break it. When the recession ended in 1982, financial markets rallied explosively--the beginning of the "superbull" stock market--but Volcker continued to restrain growth in the real economy, keeping interest rates above normal. His purpose was to keep ratcheting down increases in the price level during the recovery cycle--gradually, in stair-step fashion, until the inflationary fears of capital investors could be fully extinguished. Greenspan took up the task after he became chairman in 1987 and continued roughly along the same path of slow, steady disinflation (albeit with occasional setbacks). Eventually, he achieved the goal--low and stable inflation rates, as near to zero as plausible. In the annals of central banking, this was a great victory. But it was not pretty.

The long process of disinflation--measured by the falling rate of increases in the Consumer Price Index--meant the Fed was gradually "hardening" the value of America's money. A dollar, for example, was losing 10 or 11 percent of its value when the CPI was briefly rising in double digits during the 1970s inflation. But with the inflation rate steadily subsiding, moving downward in most years, the dollar's value was growing, particularly if it was invested in the future through stocks or bonds. Thus monetary policy effectively delivered a discreet dividend, year after year, to the wealth-holders. Not surprisingly, they felt good about this (even if they didn't understand why it was occurring). Their stocks and bonds or other financial assets would automatically be worth a bit more when they sold them because they would be paid in harder dollars--currency that had more purchasing power than the dollars they had originally spent to purchase the stocks or bonds. The silent, annual bonuses and the revived optimism among investors together fueled the soaring stock market that has stretched across the past eighteen years.

Industrial workers, on the other hand, felt lousy, as did a majority or more of all wage earners, because their wages were being discreetly depressed, in real terms, by the same process. With the slower growth and higher unemployment artificially induced by Fed policy, wage increases were naturally subdued or nonexistent, especially among those in the bottom half with little or no bargaining power. In fact, for most of Greenspan's tenure, average wages did not keep up with inflation. Many families experienced the paradox--their purchasing power seemed to be shrinking, even though inflation rates had fallen. Confused people sometimes blamed this squeeze on rising prices when the real problem was stagnant or falling incomes.

The Federal Reserve was in fact explicitly targeting the wages of the American work force as a principal threat to economic stability. Greenspan articulated the connection less elliptically than Volcker, but one still had to parse his sentences carefully to get his meaning. Neither media nor politicians bothered to explain it very directly. This subtext of "winners and losers" helps explain why opaque technical verbiage surrounds the conduct of monetary policy. Who wants to tell the workers their own government is holding down pay? It also explains why, even after four years of accelerated growth, lower unemployment and rising real wages, so many American families refuse to join the celebration. Either the "good times" never got to them or they are still trying to get well from the Fed's old medicine. Despite the boom, hourly wages in manufacturing remain mired, in real terms, at 1970s levels. For families at the median household income level, it has taken nine years to get back to where they were in 1989 (before Greenspan's 1990 recession hammered their incomes).

Among financial types, Greenspan's logic was sometimes called "the 2 by 2 economy"--2 percent growth, 2 percent inflation--better known as Goldilocks. As Greenspan repeatedly proclaimed, it was impossible for the US economy to grow faster than 2-2.5 percent a year without reigniting fierce inflation, a ceiling he derived from expected growth in productivity and the labor force. The operating corollary (the theorem known as NAIRU) translated this growth ceiling into a somber rule: The unemployment rate must not be allowed to drop below 6 percent. Such rules were invoked regularly to justify Greenspan's "pre-emptive strikes" against inflation and faster growth--raising interest rates when prices were subdued or even falling, slowing the economy when its productive capacities (plants and people) were still vastly underutilized. The danger that most spooked the governors was the threat of rising wages.

Spirited critics from left and right did challenge this logic (futilely, since Clinton and both parties passively adhered to Greenspan's dictum), and the supposed threat of inflationary wages proved to be nonexistent. As some of us argued, globalization and the competition from cheap labor overseas were imposing a most effective brake on both US wages and consumer prices (global influence on US markets is among the economic realities the Federal Reserve steadfastly ignores in its calculations). Corporate downsizings added to these pressures. For the record, the critics' arguments have been spectacularly confirmed by events and, ironically, by the Greenspan boom itself. Once the Federal Reserve relented in early 1997 and permitted faster growth to unfold, wage increases picked up smartly and started making real gains against inflation, while the CPI held steady. The unemployment rate fell below 6 percent, then 5 percent, then even 4 percent, yet the calamity predicted by the Fed in such circumstances never occurred. Woodward describes Greenspan as puzzled by the absence of wage inflation. Is the "traumatized worker," he wonders, afraid to ask for more?

Actually, the only visible price inflation was in the stock market--a developing bubble in asset prices that began to worry Greenspan too. In late 1996, when the Dow Jones Index was above 6,000 (the long rally had started at 900 back in 1982), Greenspan famously called it "irrational exuberance." Yet he did nothing to interfere. The Fed had launched the giddy run-up in financial markets and sustained it for many years, but the Fed has disclaimed any responsibility for what would happen on the downside. Greenspan waved away critics urging him to use the Fed's regulatory tools to curb the easy credit available to Wall Street's high fliers. The chairman essentially does not believe in regulation--not when it applies to his own constituency. The Dow peaked last year at 11,800 and is returning to earth. One of the reasons the stock market lost its luster is that the Fed's annual disinflation bonuses ended. Financial rates of return are subsiding back to normal ranges, and there's nothing Greenspan can do to stop the pain.

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