Why Does The Federal Reserve Go To War With Workers?

The Federal Reserve is due to raise interest rates today, June 15th, so much so that most economists agree it will cause a recession next year.

I doubt anyone in the Federal Reserve hates workers. But, University of Texas economist, Economist James Galbraith argues that the Fed just acts like it hates workers.

What is the Fed Thinking?

The way the Fed is thinking and the interpretation of its role to stop inflation at any cost is key to their hostile labor actions.

Here is what the Fed is thinking. Interest rates are the cost of doing business, construction depends on debt, house buying depends on mortgages, business borrow money to expand and survive. By raising the cost of doing business the economy slows and the Fed engineers a recession. Recessions cause unempoyment inhibiting workers’ ability to get better pay and working conditions.

But as Josh Bivens at the Economic Policy Institute economist argues we don’t need a recession to inhibit worker bargaining power. Worker bargaining power is already inhibited. Workers real wages have declined over 3%. In May, over the past 12 months, average hourly earnings have increased by only 5.2 percent and inflation is up 8.6% which translates into a three percent decline in real wages.

The Current Fed Thinking Is Based on a Wrong Interpretation of the 1980s OPEC Recession

The Fed’s thinking is old and outdated and based on a false reading of what happened in the 1980s. When the 1979 Iranian Revolution curbed global oil supply and caused oil prices to rise sharply in 1979 and early 1980 the Fed Chair at the time—Paul Volcker— engineered a spike in interest rates and a historically deep recession. Only the Great Depression and the recession in 2008 topped it.

Curbing price increases was Volcker’s major goal, he engineered high unemployment which reduces workers’ bargaining power to get improved wage and working conditions. And, Volcker knew what he was doing. He said to a New York Times
NYT
reporter in October 1979, “The standard of living of the average American has to decline,” he said. “I don’t think you can escape that.”

The Volcker recession was called a great success for stopping inflation by knocking the life out of worker and business’s expectation that prices would always increase. These expectations can lead to a self-fulfilling prophecy.

Conventional wisdom sys that the Volker recession conquered inflation and “buried the Phillips curve” — an economic relationship showing that inflation and unemployment move in opposite directions — by eliminating worker and business expectations that prices would always go up.

Fed Economists Challenge the Fed

Two Fed economists, David Ratner and Jae Sim, are challenging their employer by arguing it wasn’t so much the Fed, but government and corporate anti-union labor market policies that eroded worker bargaining power and put a stop to wage increases. The lesson here, these economists are saying to their boss, is that worker power is already flattened.

The implication is that we should search for other ways to fight inflation.

Workers Aren’t Causing Inflation

As Galbraith points out this current bout of bad inflation numbers is an overhang from the last 12 months. This pandemic phase started in 2020 by a surge in world oil prices, rising used-car prices and famous supply chain problems. People with money and credit are chasing a few houses on the market, desperate to get a land asset. House price increases add to inflation. And the war in Ukraine is causing food and fuel inflation. As Mark Zandi from Moody Analytics writes, by far the war in Ukraine is the biggest driver of inflation. A U.S. recession is not going to stop the war in Ukraine.

Increasing the supply of housing, finding alternative sources of fuel, releasing tons of Ukrainian grain would be effective ways to fight inflation.

I share Galbraith’s concern that the Fed is headed in the wrong direction. Recessions hurt more than inflation. Unemployment hurts the unemployed to be sure, but also the family of the unemployed, especially the children.

Unemployment hinders maturation, new graduates will have more trouble finding jobs. And workers will curb their deamnds for better pay, fearing they will lose their jobs. But, as explained, this fear is precisely what the Fed is after.