Getting Workers’ Minds Right at the Fed
(posted by Kevin Carson)
Regular commenter quasibill, on the LeftLibertarian2 list, linked to an excellent article on Federal Reserve policy and inflation. Here’s the money quote (no pun intended):
A popular misconception is that inflation cannot occur in an economy without wage inflation to transmit prices into all-goods prices. Indeed the Fed has waged war on wages since the early 1980s so this point of confusion is understandable…. But wage inflation is but one of a long list of factors that can create an inflation spiral.
Labor discipline, in fact, has been a central objective of Federal Reserve policy since Volcker’s recession in the early ’80s.
Brad DeLong considers the Fed’s policy to have played a significant role in worsening income inequality over the past three decades. In evaluating the contributing factors to stagnant wages and exploding corporate profits and management salaries, DeLong weights at about 30% the importance of “the high unemployment of the Volcker disinflation” as a cause of the “shift of power away from workers.”
In fact, that was the theme of a This Modern World comic a few years back: “Greenspanman” (click on it–it’s hilarious).
Greenspan just the same as admitted that “inflationary pressure,” in operational terms, translates into increased bargaining power of labor. And conversely, when the Fed talks about reducing inflationary pressure, what it really means is reducing the bargaining power of labor. Back in the 1990s Greenspan persuaded the Fed to keep interest rates low despite record low unemployment, because (as he testified back then) the job insecurity in the tech economy was almost as good as high unemployment as a way to reduce the bargaining power of labor. In 1996, 46% of workers at large firms were fearful of layoffs, compared to only 25% in 1991. And, Greenspan added,
The reluctance of workers to leave their jobs to seek other employment as the labor market tightened has provided further evidence of such concern, as has the tendency toward longer labor union contracts. For many decades, contracts rarely exceeded three years. Today, one can point to five- and six-year contracts–contracts that are commonly characterized by an emphasis on job security and that involve only modest wage increases. The low level of work stoppages of recent years also attests to concern about job security.
April 13th, 2008 at 11:20 pm
I’m under the impression that the inflation of 1970s America, Weimar Germany and modern-day Zimbabwe was no picnic for laborers. How do you determine whether rates should be higher or lower?
April 13th, 2008 at 11:58 pm
I’m not sure I do. The point was, though, that wage-demand inflation has been a comparatively insignificant contributing factor, and yet the Fed has treated tight labor markets as a proxy for inflation. In so doing, their policy of “fighting inflation” has translated in practice into weakening the bargaining power of labor as such.
April 14th, 2008 at 7:06 am
1 - I can’t recommend iTulip enough to people who want to understand what’s going on in the economy and where we’re headed. The general basis seems to be Austrian influenced, but they aren’t an echo chamber, and bring in, for example, the concept of the FIRE economy from Kucinich’s economic advisor. Janszen writes well, and makes good use of graphics and charts to spice things up. Well worth checking in there on a weekly basis to see what’s up.
2 - It’s always dangerous to focus too much on inflation/deflation. More important is to focus on who has the privilege of printing new money to cover their losses.
That said, the inflation question is very complicated with respect to how it affects labor. The counter-balance to the tendency Kevin highlights is the ability of unions and other strong bargaining position labor to prevent downward modifications of labor costs during deflationary or times. The flying monkeys of the FIRE economy (sorry, I love that phrase - I’m an Oz fan) have a theory called downward wage rigidity, and they claim that low to moderate inflation (1-3%) is absolutely necessary to allow them poor ol bosses to make a decent return on their investment over time, as the greedy workers will refuse to take wage cuts. The inflation forces the workers to take real pay cuts, even if they get nominal year end raises.
Funnily enough, Bernanke’s policy until the S started HTF was to ‘target’ CPI inflation at 1-3%. He never publicly endorsed DWR, but it sure looks like that’s what he was following. And we should always note that CPI understates real inflation by at least a factor of 2 (vulgar liberarians often commit the broken window fallacy when they argue that CPI overstates inflation).
Now, all bets are off, because his buddies need to be bailed out. The central bank appears to be ready to throw everyone else under the bus (even other partners in the ruling coalition) to maintain the centrality of financial sector in the economy.
April 14th, 2008 at 12:00 pm
quasibill,
If what some people are saying about M2 being pumped up 10% a year for the past few years, I’d guess labor is taking a lot more than a modest pay cut. Of course, that means the Dow is falling by almost !0% a year when it appears to be stable or modestly rising.
April 14th, 2008 at 4:45 pm
Kevin,
So, would you say that the Federal Reserve distorts the economic “laws” of supply and demand? And thus distorts the credit market overall in favor of capitalist banking interests?
I am trying to understand your perspective clearly here.
April 14th, 2008 at 7:56 pm
Natasha,
Well, I do think it distorts the credit market in favor of capitalist banking interests–something quasibill can probably comment on more intelligently than I can. But my point here is that it distorts the labor market by raising interest rates whenever it gets too tight, and is motivated to do so by viewing a tight labor market as the main source of inflationary pressure.
April 15th, 2008 at 7:24 am
The Fed’s focus on “wage inflation” as an evil is easy to understand if you recognize that “asset inflation,” or “asset bubbles” is their main goal. They want assets in general to appreciate faster than the average price index, and have recently (20 or 30 years) discovered the strategy of blowing bubbles in select asset classes. They use tax policy, government subsidies, and other state tools to create a bubble in a given asset class, and the Fed connected bankers are always the first into the bubble, and therefore reap the greatest gains from the appreciation. But they also generate substantial fees for all the financial instruments that get created during the bubble.
Some of the weaker elements don’t get out of the bubble soon enough, or don’t shift enough of the risk out, and get caught on the downside (Bear Stearns), but by and large, the bankers make out very well from these bubbles. I agree with Janszen that the next bubble that they’re trying to blow is an energy/infrastructure bubble. I think I’m just a little less confident than he is that it won’t all just collapse due to an unforseen complication.
April 15th, 2008 at 12:10 pm
I’m not sure that the Fed is actually motivated by a fear of wage-induced inflation. I think they’re motivated by a desire to maintain the rate of return on financial assets. The Fed should be analyzed just like any other regulatory agency — it is bound to be captured by the industry it regulates and was probably deliberately created by that industry specifically to enforce oligopoly conditions.*
Once seen in that light, the Federal Reserve will take whatever action is most favorable to the largest firms in the financial sector. By and large, the incentive cycle is steady inflation followed by occasional recessions to squeeze out inflation expectations and purge bad investments. The larger firms weather the storm of recession and acquire and/or bankrupt smaller firms. The eventual end to this process is when the financial sector becomes so concentrated and so successful at riding the boom that the financial sector itself becomes the heart of a bubble.
At that point, a recession results in a catastrophe like the Depression — unless the Fed is willing to destroy the currency in order to wipe out the debts of the biggest firms. Since a hyperinflation destroys the credibility of a currency and makes it substantially more difficult to inflate later, the incentive will be to avoid hyperinflation right up until the point where such a strategy is the only way to save the fortunes of the largest firms.
In other words, unless Goldman Sachs is going to fail, expect a recession. If Goldman Sachs is failing, then expect a depression — unless the Fed can see this far enough in advance, in which case expect hyperinflation.
Most of the debates in bearish circles regarding the nature of the crisis we face boil down to an assessment of how alert and/or how effective the Fed is. That assessment seems largely based on the temperament of the commentator rather than any real economic theory (its basically Kremlinology for the Fed).
* There is substantial evidence that the Fed was created to more or less the exact specifications desired by major Wall Street banks — notably the Jekyll Island meeting of 1910.