The Federal Reserve’s Answer to Inflation Is Class War

The price of a dozen eggs hit an average of $2.70 in June, up from $1.64 last June. A gallon of gas, meanwhile, has been hovering around $5, pricing the average commute at about $30 per week. According to the most recent data released by the Labor Department, price inflation of everyday goods and services reached 9.1% this June — the highest level in more than four decades. At the top of the list of goods with the biggest price hikes are the bare necessities: rent, food and fuel.

Because wages haven’t kept pace with rising costs (they’ve grown at only half the rate of inflation), and lower-income households spend over three-quarters of their income on necessities, the pain of inflation falls mostly on poor and working people, and disproportionately impacts people of color. This follows a well-worn historical pattern. As economist Diane Schanzenbach told the New York Times: ​“Low-income workers, workers with low levels of education, Black and brown workers are the first to lose their jobs and the last to get them back.”

Getting inflation under control has become a top priority for President Joe Biden, whose approval ratings recently hit their lowest point yet: just 36% as of July 6 — rivaling Donald Trump’s lows. Even among Democrats, approval for Biden’s presidency dipped to 69%, down significantly from 85% last summer. The economy has remained the number one concern for 43 weeks running.

But Biden is relying on the Federal Reserve to choke inflation, rather than instituting any policies to protect workers’ pockets. According to Politico, ​“Biden declared his ​‘laser focus’ on inflation while meeting at the White House with Fed Chair Jerome Powell… and backed the central bank’s aggressive interest rate hikes, which are aimed at cooling the economy by any means necessary, including inducing a possible recession.”

The medicine the Fed has on offer is the same toxic elixir it’s had on its shelf for decades — hiking interest rates to ​“cool” the economy. This approach is a case of medicine that is worse than the disease. Cooling off the economy is a euphemism for scaling back investment in the economy, thereby driving up unemployment and decreasing workers’ bargaining power. Interest rate hikes have the power to ​“cool” the economy, because they make it more costly to borrow money, and therefore discourage investment in production. This, in turn, leads to reduced productive capacity, fewer available jobs, and an increase in unemployment.

Most mainstream economists assume that even if external factors — such as pandemic-induced supply chain chokeholds — trigger price hikes in the economy, any sustained inflation is caused by too low unemployment. A tight labor market means that workers cannot be easily replaced, and therefore they enjoy greater bargaining power, which eventually leads to higher wages. These elevated wages in turn give working people more money to spend, driving up demand for goods. And businesses look to hike prices in order to pass on the rising cost of wages to consumers.

The fact that wages have not, in fact, kept up with inflation should be cause for skepticism. Nevertheless the Wall Street Journal confidently explains:

[D]ynamics [of a tight labor market] are driving wage growth, adding to inflationary pressures. Strong gains in wages and hiring are pumping more money into Americans’ bank accounts, propping up demand as inflation erodes spending power for many. Meanwhile, higher labor costs stemming from worker shortages are prompting many employers to raise prices.

Since March, the Fed has raised interest rates (via its benchmark federal-funds rate) three times, including 0.75% last month — the highest interest rate hike in 28 years. It’s indicated a total of seven increases this year are likely. We don’t know how far the Fed will go, or how severe a recession it will induce. But rumblings of a coming recession are growing. Over the last few weeks, Powell has repeatedly stressed that the Fed will continue to raise rates until inflation is under control, even if that means causing a recession.

Speaking at the European Central Bank’s annual conference, Powell said, ​“Is there a risk we would go too far? Certainly there’s a risk. The bigger mistake to make — let’s put it that way — would be to fail to restore price stability.”

“The process is highly likely to involve some pain,” Powell later added, ​“but the worse pain would be in failing to address this high inflation and allowing it to become persistent.”

So far, job growth over the last couple of months has remained steady. But the aim of the Fed’s actions remains to slow economic growth, just at a time when savings accumulated during the pandemic have been drawn down, and credit card balances are approaching record highs. The simultaneous effect of interest rate hikes and likely job losses on the one hand, while prices and the cost of living are still rising on the other hand, will exact a heavy burden on working people. Indeed, economists promise us a difficult ​“transition” at best, as inflation typically takes a long time to come down after a slowdown.

Giving the Fed Free Reign

Biden’s support notwithstanding, the Federal Reserve is free to act without direction from the White House or Congress. This independence is often lauded as a means to guard against political pressures, thereby granting the Fed objective stewardship of the economy. In reality, ​“independence” is a positive spin on the country’s arguably least accountable, least democratic institution. While every detail and line item of congressional stimulus bills has been debated and deliberated over — even if the outcome remains undemocratic — the Federal Reserve takes hugely consequential decisions without even the pretense of public discussion or oversight.

Nor is ​“objective” economic stewardship a plausible reality. Economics and politics have never been separate entities, and the question of inflation is no exception. As I’ve written elsewhere, inflation is always a question of class politics — which class gains at whose expense. Who pays for inflationary prices is ultimately a question of who gets what share of the national income. A rise in wage share will squeeze the profit share of income, and vice-versa.

Economic pundits conspicuously avoid the possibility of addressing inflation by constricting profits rather than wages. What if instead of raising prices, businesses were forced to make do with smaller profit margins? Or if instead of raising interest rates to constrict the economy’s growth, targeted price controls and socialization of public needs were used to lower the cost of living? After all, U.S. corporations are not only charging more, they’re also making higher profits. S&P 500 companies (the country’s largest companies) are raising their prices by about 20% more than the rate of inflation for wholesale prices. Their profit margins (12.1% in 2022) are at record highs. Many oil companies’ profits per gallon of gas are at their highest point in history.

The Federal Reserve is not necessarily opposed to wages rising, but only in so far as these raises are contained within certain parameters that do not risk creating inflationary pressures. Thus, as Tim Barker, a historian of political economy, has argued, hawkish Federal Reserve policies since the 1970s have ​“played a direct role in the decline of the labor share since the 1970s.” (“Labor share” refers to the share of the national income that goes to wages and salaries, rather than profits.) And while a more dovish turn since 2016 — allowing the economy to expand despite low unemployment rates — did lay the basis for more pro-labor conditions, this experiment was only allowed to run as far as it did not endanger inflation.

Low interest rates for over a decade created the conditions for low unemployment rates by feeding the economy with cheap credit. But it also, in Barker’s words, ​“opened new horizons for a would-be activist government” by lowering the cost of government debt, and therefore deficit-driven social spending. Yet as Barker presciently argued a year ago, this flexibility in the Fed’s actions was not a concession to workers gaining a greater share of the national income. It was only predicated on an assumption that the labor movement was too weak to make substantial wage gains, even in the context of low unemployment rates. ​“The current experiment,” Barker explained, ​“was made possible by a recognition that workers had suffered a secular defeat — specifically, that they had lost the ability to increase or even defend their share of the national income. What would happen if labor became stronger?”

The Federal Reserve’s conventional playbook has, since the 1970s, been informed by ​“monetarist” ideas first championed by economist Milton Friedman. Friedman stated that a ​“natural rate of unemployment” exists below which inflation begins to take off. There may be debates and turns at the Federal Reserve that have taken place since the 1970s, but they have only challenged how low the rate of unemployment can be allowed to go without risking inflation, not whether profits could ever be sacrificed to a larger labor share of the economic pie.

A year ago, when the prospect of inflation first reared its head, talk of rolling back government stimulus was still an outlier position. But as Barker predicted, this argument would soon predominate again:

[E]ven with the economy still millions of jobs shy of its pre-pandemic level, there is already an organized attempt to cut short the expansion and declare the experiment a mistake. So far, the major backlash constituencies are low-wage employers and scorned economists, but their complaints will find a bigger audience at some point in the next few years.

An Alternative Path

In 1977, Arthur Burns, then chair of the Federal Reserve, spoke to students at Gonzaga University at their campus’s ​“Founder’s Day” gathering. He warned them of a ​“disturbing” trend in which U.S. profits are ​“unsatisfactory,” and yet economists are paying too little attention to this problem. Our economy, he reminded the audience, ​“is still predominantly a profit-motivated economy in which, to a very large extent, whatever happens — or doesn’t happen — depends on perceived profit opportunities.”

The long-term problem we face is exactly as Burns articulated. A capitalist economy is, by definition, held hostage to calculations of profitability. This impacts whether investment flows towards planet-destroying industries or to protect human health. But it also forces us to shoulder the consequences of a rollercoaster in prices, and the difficulties of maintaining a balanced supply-and-demand across industries.

Causes of inflation are always complicated to assess, even in hindsight. And today’s inflationary crisis is, of course, still unfolding. But most economists describe supply chain chokeholds as playing a significant role, at least in triggering the current situation.

In the early months of the pandemic, when much of the country was at home during lockdowns, many industries shrank. Those businesses that remained open reduced production capacity and inventory. When the economy began to reopen, pent up demand mixed with a fair amount of accumulated savings, quickly drove up sales of both goods and services and led to chokeholds in supply chains. When supply doesn’t match rising demand, buyers are essentially pitted against each other in a bidding war for goods, allowing companies to drive up prices.

A number of factors have sustained inflation beyond the initial triggers. The neoliberal penchant for just-in-time production has ensured that thin inventories could not quickly be ratcheted up. Then specific events like Russia’s invasion of Ukraine have played a role in keeping oil prices high. Oil prices, in turn, impact almost every other part of the economy. Increasing numbers of droughts are also driving up the prices of crops. Meanwhile, as Biden has occasionally acknowledged, old-fashioned price gouging plays a key role. Companies take advantage of increased demand to raise prices much further than the growing costs of their inputs (both labor and materials). This feeds into a ​“profit-price” spiral, rather than the oft-talked about ​“wage-price” spiral.

Workers’ demands do also drive up inflation. The fact that wage gains are lagging behind inflation is a good indication that wages aren’t a key driver. But broader, pro-worker policies like pandemic era benefits, which were largely deficit-driven rather than backed by increased taxes, put more money in circulation and therefore increased inflationary pressures. Were they financed by higher taxes — with at least a lion’s share being paid by the ultra-wealthy — they would be easier to sustain without risking inflation. That’s an immensely important goal. Those benefits were critical, not only to keeping millions of households afloat, but incredibly they reduced the level of poverty in the midst of a tremendous economic crisis.

These are positive achievements worth defending and extending. In order to do so, the left will need to both counter the claims that workers must pay for inflation, and put forward our own solutions to addressing inflation. As a starting point, some progressives within the Democratic Party are calling for enactment of components of Build Back Better, which would, for instance, lower the burden of childcare and prescription drug costs. Taking aim at housing costs should be another key component of a left economic agenda. Indeed, the Wall Street Journal reported that levels of inflation vary by region, largely due to housing costs:

Inflation was highest in the South, at 9.2%, and the Midwest, where prices rose 8.8%. Residents of the Tampa-St. Petersburg-Clearwater area of Florida swallowed an 11.3% increase over the 12 months ended in May, driven in part by a sharp rise in rental prices. Inflation was just 6.3% in the New York City metropolitan area, due in part to relatively low rental-price gains.

Beyond these immediate demands, a longer-term strategy should focus on targeted price controls, and nationalization of state-dependent industries like oil. As economist Doug Henwood has argued, increasing taxes — certainly on the rich, but also on the comfortable — should be part of any redistributive ambitions, if we want to make those economic gains stick.

Ultimately, the capitalist class, left to its own devices, will get out of this crisis by exacting enormous amounts of pain from workers. At the heart of a left economic agenda needs to be an understanding of inflation as a site of class conflict, and to organize our side accordingly. This requires both specific policy demands, and a labor movement that can organize for concrete economic gains and against the pressure to make workers pay for a crisis they did not create.