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Fed's Pre-emptive Strike Is Aimed at Workers
By Marc Weisbrot
The Fed launched a "pre-emptive strike" this week against an
unseen enemy
-- inflation -- by raising interest rates one-quarter percentage
point.
With inflation at its lowest level in 30 years (2.1%), why would
the Fed
want to start down a path that could cost hundreds of thousands
of workers
their jobs, slow the growth of wages, and raise the cost of
borrowing to
millions of home owners and consumers?The Fed's rationale is
that labor
markets have gotten "too tight." For most Americans, the idea of labor
markets being "too tight" makes about as much sense as the air getting
"too clean" or people being "too happy." They have a hard time
understanding the hidden dangers of increasing job opportunities and
paychecks.
But the Fed has a theory in which this all makes sense. The Fed's theory
says that if unemployment gets "too low," employees will begin to demand
higher wages and salaries. That could cause employers to raise prices,
leading to more wage demands. The Fed's great fear is that an
"inflationary wage-price spiral" will spin out of control.
There has never been much evidence to support this theory. Some have
argued that the Fed is still fighting the last war -- the inflation of the
1970s. But even that inflation was the result of rising oil prices, not
tight labor markets. Previous bouts with inflation in the United States
have generally resulted from wars or other external events.
The holes in the Fed's theory have been getting bigger and more numerous
each year, to the point where there is hardly anything left of it. Until
four years ago the Fed (along with most prominent economists) thought that
6 or 6.25 percent was as low as unemployment could fall without
accelerating inflation. That part of the theory has gone straight to the
trash heap, as unemployment has fallen to 4.2 percent while inflation has
actually declined.
The structure of our economy has also changed since the Fed fought its
last battles against inflation twenty years ago. There is a good deal more
competition, especially from the international economy. While the majority
of employees have not benefited from this increased competition -- their
real wages have been declining for more than two decades -- it does make
it more difficult for companies to raise prices.
The Fed has recognized some of these changes but doesn't seem to know how
to reconcile them with its dogma. According to the minutes of its February
meeting, a number of Fed policy makers "suggested that the inflation
process was not well understood and that inflation forecasts were subject
to a wide range of uncertainty." The New York Times aptly noted that this
was "like a conference of top cardiac surgeons deciding that it did not
really know how the heart works."
Last year the Fed lowered interest rates by three-quarters of a point, in
response to instability in the international financial system. And Fed
Chairman Alan Greenspan has also been afraid that raising interest rates
might tank a stock market that he knows is highly overvalued -- he does
not want to get blamed for a crash. But he seemed to be preparing the
public for this possibility in his last speech: he noted that the bursting
of a financial bubble "need not be catastrophic," and that the stock
market crash of 1987 "left little lasting imprint on the American
economy."
The Fed argues that we can't wait until we can actually see inflation
rising before taking action to slow down the economy and wage growth. A
host of soothing metaphors in the business press, such as "tapping on the
brakes," or bring the economy in for "a soft landing" have substituted for
evidence and logic in shoring up the Fed's argument.
But the real threat to our economy is not from rising wages but rising
interest rates. The conventional wisdom has it backwards: by the time the
Fed has done its damage, it will be too late (as in 1990) to avoid a
painful recession.
We need a pre-emptive strike, all right -- not against inflation, but
against the Fed.
Mark Weisbrot is Research Director at the Preamble Center and a research
associate of the Economic Policy Institute, in Washington, D.C.
A<>E<>R
~~~~~~~~~~~~~~~
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