The Federal Reserve is now engaged in a concerted program to increase unemployment from its current low rate of 3.5 percent and to strip US workers of the small gains in bargaining power they have achieved in the aftermath of the Covid economic lockdown. Federal Reserve Chair Jerome Powell acknowledged this clearly, if demurely, in a major speech last month, where he predicted that there would “very likely be some softening of labor market conditions” resulting from current Fed policy. The Fed is advancing this program in order to bring down the high inflation rate that has emerged in the past year. As of the most recent August figures announced on Tuesday, average prices for consumers (measured by the Consumer Price Index) rose by 8.3 percent relative to a year ago. Though somewhat lower than the 9.1 percent peak figure for June, this is still higher than at any other point in the past 40 years.
The Fed is attacking workers’ bargaining power because, as of the most recent June figures, average wages rose by 5.1 percent relative to the previous year. The Fed, along with most mainstream economists, assume that businesses will raise their prices to cover these wage increases, so that wage increases automatically drive inflation. But this does not necessarily follow. At least in part, businesses could also absorb higher wages—either through increasing the productivity of their operations or by accepting somewhat lower profits. In fact, businesses have been raising prices faster than wages have gone up, so that profits have kept rising in the post-lockdown recovery. Meanwhile, for average workers, their 5.1 percent wage increase is 3.2 percentage points below the 8.3 rise in overall prices. Which amounts to a 3.2 percent pay cut in terms of what the workers can buy with their wages.
The Fed’s program to attack workers’ bargaining power is straightforward. It entails raising interest rates to make it more costly for businesses and households to borrow money. With credit becoming more expensive, households should then reduce their spending, especially for big-ticket items such as houses, cars, and appliances. Businesses will respond to this decline in overall spending by tightening their operations. Workers will face layoffs as a result.
Fed policy-makers and virtually all mainstream economists agree that the US working class needs to swallow this bitter medicine for the greater good of controlling inflation. The current debate within these circles focuses on a narrower question: Can the Fed bring down inflation to around 2 percent without inducing a deep recession? Optimists at the Fed argue that a “soft landing” is still possible, citing evidence that labor market conditions have been loosening for the past month. Pessimists such as Larry Summers counter that the plan cannot work without a major recession in which unemployment rises to 6 percent or higher.
The touchstone for this debate is the experience of the 1970s and early 1980s. Inflation averaged 9.0 percent between 1974 and 1982, peaking at 13.6 percent in 1980. To stop this persistent inflationary spiral, Fed chair Paul Volcker raised the Fed’s policy interest rate massively, peaking at an extraordinary 19.1 percent in January 1981. This did produce a precipitous fall in inflation, to 3.2 percent by 1983. But it also created a severe global recession, with US unemployment rising to 9.7 percent in 1982 and Latin America descending into a debt crisis and a “lost decade” of economic decline.
Despite these huge costs, both sides of the current debate portray Volcker’s actions in heroic terms, fully worthy of emulation today. Yet, in doing so, both sides overlook the critically different circumstances between the Volcker era and now, beginning with how high inflation emerged in both periods.
Oil Shocks vs. Covid Lockdown
Inflation in the 1970s and early 1980s resulted from the oil-producing countries (OPEC members) and private oil corporations such as Exxon exercising monopoly power to quadruple oil prices in 1973, and then to double prices again in 1979. By contrast, the current bout of high inflation resulted from policies in the United States and other advanced economies to prevent an all-out economic collapse—on the order of the 1930s Depression or worse—in the face of the Covid pandemic and March 2020 global lockdown. In the United States, the federal government injected nearly $5 trillion in spending to prop up the economy between March 2020 and March 2021—equal to nearly 25 percent of GDP. The Fed itself bought another $4 trillion in financial assets to keep Wall Street afloat. There were massive disparities in who got what from these government spending injections. Big corporations, for example, received billions in bailout funds without even being required to keep their employees on payroll. Nevertheless, these measures did prevent an economic collapse and powered a rapid recovery.
As a result of the March 2020 Covid lockdown, unemployment jumped from 3.5 percent in February to 14.7 percent in April, creating more than 18 million newly unemployed people. But due to the stimulus programs, unemployment fell back to 3.5 percent in less than 2 years. By comparison, it took more than 10 years for unemployment to fall from 10.0 to 3.5 percent in the aftermath of the 2008-09 financial crisis—even though Obama’s 2009 stimulus, at nearly 10 percent of GDP, was the largest peacetime intervention prior to 2020.
In short, the outsized stimulus measures under Covid reflected the view expressed by Fed chair Powell in 2021: “I’m much more worried about falling short of a complete recovery, and losing people’s careers and lives that they built, because they don’t get back to work in time.”
Powell recognized that, without the stimulus policies, we would have experienced deflation instead of inflation—i.e., sharply falling prices, wages, and incomes along with a rise in loan defaults and a teetering financial system; in short, a 1930s-type scenario. Moreover, the risks of deflation and depression in 2020-21 were global in scope, just as the emergence of high inflation from late 2021 until now has been a global pattern. The overall European Union inflation rate is currently 9.8 percent, up from 2.5 percent a year ago.
Powell’s 2020-21 stimulus policies were intended to expand overall demand in the economy—and they did. But they also created the unintended effect of demand outstripping supply. Supply shortages resulted, especially given that production of goods had been scaled back sharply across-the-board during the lockdown. Businesses then took advantage of these supply shortages to mark up prices as much as they could. In particular, energy prices rose by nearly 33 percent and food prices by nearly 11 percent between July 2021 and July 2022. Russia’s invasion of Ukraine in February worsened the supply shortages for food and energy, and speculative trading on global commodities markets pushed these prices up further. The stimulus programs also created a financial bubble on Wall Street. It is telling that those policymakers and mainstream economists now adamant about stopping 5 percent wage gains raised no objections to stock market prices rising by 46 percent during the lockdown, with speculators’ profits spiking as a result.
40 Years of Wage Stagnation
The other big difference between the early 1980s and the present is the relative conditions faced by the working class in both periods. Average real wages in the United States—i.e., after controlling for inflation—had risen by nearly 50 percent between 1960 and 1972, just prior to the first 1973 oil price spike. But real wages have stagnated ever since. In 1972, the average nonsupervisory worker earned $25.28 per hour, adjusted for inflation, while, as of 2021, the average worker earned $25.18. This at a time when labor productivity—the average amount each worker produces over the course of a day—increased by nearly 250 percent between 1972 and 2021. If, between 1972 and today, average wages had risen in step with productivity gains, and not a penny more, the average worker’s hourly wage in 2021 would have been $61.94, not $25.18.
The idea of holding real wages stagnant for over 40 years has been a cornerstone of neoliberal policy, as initiated in the early 1980s by Ronald Reagan along with Volcker in the US as well as by Margaret Thatcher in the UK. Indeed, this was the most important force holding inflation down, even when unemployment fell to relatively low levels, such as in the late 1990s. Alan Greenspan, who succeeded Volcker as Fed chair in 1987, acknowledged as much when he described the US working class as having become “traumatized” by global outsourcing and the decline of union strength even when unemployment was low.
More generally, wage stagnation in conjunction with rising productivity has been central to the persistent rise of inequality in the United States. This is straightforward: If workers aren’t receiving raises in step with the growing economic pie, then somebody else must be getting bigger and bigger pie slices. Under neoliberalism, the pay for big corporate CEOs rose from being 33 times higher than the average worker in 1978 to 366 times higher in 2019—i.e., a more than tenfold increase in relative pay. The Fed’s current policy amounts to embracing the principle that US workers cannot be allowed to gain enough bargaining strength to push up wages and reverse 40 years of rising inequality.
Are There Alternatives?
Of course. For starters, both Fed officials and mainstream economists are fixated on bringing inflation down to 2 percent. But why 2 percent? In fact, there is no consistent relationship between inflation, economic growth, and unemployment. Focusing on just the high-income (i.e., OECD) economies since the 1960s, relatively high inflation, even in the range of 10 percent or higher, has been associated with periods of both high and low growth, depending on the specific circumstances. By itself, an average inflation rate in the range of 3-4 percent, as opposed to 1-2 percent, is not a serious problem, as long as that somewhat higher inflation rate results from increased wages and a more equal distribution of the economy’s overall economic pie.
With respect to the energy sector, where prices have risen most sharply, government policy needs to support large-scale investments in energy efficiency in buildings, transportation, and industrial activity. Greatly expanding public transportation offerings is one place to start. Government policy then needs to massively accelerate the production of clean renewable energy sources to supplant our existing fossil fuel energy infrastructure. It is already the case that the costs of generating electricity with solar and wind power are at parity or lower than with fossil fuels.
Such measures are also imperative for fighting climate change, which is why they are included as major features of the Inflation Reduction Act that became law in August. But not all of these energy efficiency and renewable energy investments will have immediate impacts. In the short term the government should provide people with energy tax rebates to protect them against temporary spikes in energy prices. The revenues for such rebates should come from the windfall profits tax proposals that have been introduced in Congress by Senator Sheldon Whitehouse and Representative Ro Khanna. Federal policy can also stop the speculative rise of food and energy prices simply by enforcing financial regulations already in place.
Corporate profits and CEO pay also need to be scaled back relative to the bloated levels achieved under neoliberalism. US businesses cannot expect wage stagnation and persistently rising inequality to remain as bedrocks of US capitalism for another 40 years. To the extent that corporations try to cover any and all wage increases, and then some, by raising consumer prices, the Biden administration should continue pursuing aggressive enforcement of existing anti-trust (i.e., anti-monopoly) policies to prevent these price mark-ups.
Details aside, the basic policy approach should be clear: We cannot allow neoliberalism to enjoy a new wave of legitimacy in the name of controlling inflation.