The Return of Paul Volcker

The socially astute Cardi B got it right: “When y’all think they going to announce that we going into a recession?” she tweeted on June 5. Nine days later, the New York Times caught up, blaring in a banner headline on page 1 of the Business section, “A SHUDDER RUNS THROUGH WALL STREET.” This was a definite change of tone: on April 28, the same paper had explained that bad economic news was not cause for worry: “G.D.P. Report Shows the US Economy Shrank, Masking a Broader Recovery.” If one sets aside the elements that declined, “the recovery remained resilient.” Back then it was still being noted that inflation was moderating. Then came the question whether interest-rate increases and cutbacks on bond purchases by the Federal Reserve System could control inflation without provoking a recession; by now, following Cardi’s lead, this question has been pretty much answered, in the negative, by most academic and business commentators.

What is the non-economist to make of the economic analysis and policy discussion? It’s genuinely confusing. The official story is that inflation, caused by an imbalance between government-stimulated demand and supply limited by “supply-chain shocks” and the war in Ukraine, is “hurting the economy” and squeezing wage-earners. And so the Fed must counteract inflation by slowing economic expansion, upping the number of business failures, and provoking increased unemployment. Because people– both workers and businesspeople– will then have less money, society-wide demand for goods will shrink; with demand more closely aligned with supply, prices will fall.

Why can’t the problem be solved by increasing supply? For one thing, many companies just don’t want to, because they are making money the way things are. Given the role of the internal combustion engine in Americans’ everyday lives, it’s not surprising that “the price at the pump” has become an icon of inflation. It is often pointed out by Democratic pundits that the price of oil is set internationally, so there is nothing that, say, Joe Biden can do about gas prices. And that is true: the government does not control the oil business, except in places, like Saudi Arabia, Russia, and Kazakhstan, where the government is the oil business. A New York Times article of April 27, 2022 cast some light on the question: “The biggest reason oil production is not increasing is that US energy companies and Wall Street investors are not sure that prices will stay high long enough for them to make a profit from drilling lots of new wells.” The Saudis are not interested in increasing the petroleum supply either, no doubt for the same reason. Production is so low that a considerable number of American refineries have been closed. A similar story holds for other goods whose control by a small number of corporations makes price-setting easy, such as meat, eggs, and many other things whose increasing cost is bedeviling American consumers. Rising rents are commonly blamed on the restricted housing stock, but more to the point is the international buying-up of swaths of housing by venture-capitalist firms aiming at quick profits from jacked-up rents. That is no doubt a better use for the money than building low-income housing. As JPMorgan Chase CEO Jamie Dimon said a few months ago, speaking expansively of the economy as a whole, not just his bank, “We’re going to have the best growth we’ve ever had this year, I think since sometime after the Great Depression.”¹ Everybody wants to end inflation but nobody wants to cut their profits by producing more and charging less.

And even if companies sincerely wanted to increase supply, it’s not not free: for the oil business, for instance, wells would have to be drilled, refineries reopened, and workers hired. The price of moving a shipload of containers from Asia to Europe has doubled, but building new ships takes time and is quite expensive, especially with rising prices of steel and other basic materials. To mention another supply-chain problem, trucking companies are having a hard time finding drivers. This is not surprising; truckers’ wages have been cut in half over the last few decades, and solving the problem would mean paying wages like they used to. But that of course would contribute to the dreaded wage-price spiral: if wages rose appreciably, prices would have to rise too, in order to maintain profit margins. If they could make more money by expanding production, companies would already be doing it, not stashing their cash in offshore banks, distributing it as dividends to investors, or investing it in speculative ventures like buying up the nation’s housing stock.

It’s odd for economists to say that harmonizing supply and demand may spark a recession, since the usual idea is that markets operate at their best when supply and demand coincide. In theory that’s true. But the house of theory has many rooms. Trying to figure out the coexistence of unemployment and inflation in the 1970s, some economists came up with the idea of the Non-Accelerating Inflation Rate of Unemployment, the level of joblessness at which inflation did not increase. This notion, a descendant of Milton Friedman’s conception of a “natural rate of unemployment,” now guides the Fed in its making of monetary policy. A product of pure theory, the NAIRU cannot be directly observed but only inferred–if the theory is correct--from the movement of wages and prices as unemployment rises. In 2019, Federal Reserve chairman Jerome Powell, testifying at a congressional hearing, asserted that “we need the concept of a natural rate of unemployment” to “have some sense of whether unemployment is high, low, or just right.” At the same hearing, however, Powell admitted to Representative Alexandria Ocasio-Ortez that the Fed had just recently erred in its estimate of the NAIRU.² In fact, as with many economic theories, there is no evidence that such a thing as the NAIRU exists; since the relationship between inflation and unemployment is thought even by its proponents to vary over time, there is no empirical test of the theory. Nonetheless, the idea of the NAIRU lies behind the wish that the Fed can achieve a “soft landing”--raise interest rates to just the point that stops inflation without provoking a serious recession, leaving unemployment “just right.”

But why should lowering the inflation rate risk a recession anyway? It can only be because recession conditions were being held in abeyance by whatever caused the inflation. If rising prices are the result of demand excessive in relation to supply, that demand can be traced to the massive injection of government funds into the economy, by the Treasury and by the Federal Reserve System, in response to the sharp downturn in economic activity occasioned by the COVID-19 pandemic. Low interest rates plus the flood of money led to a flow of dollars into the stock market; the money allocated to individuals and families along with the larger subsidization of businesses, while not enough to meet the rent for many, allowed the maintenance of life, if not comfortable living standards. Now that the pandemic has been declared over, the low rate of economic growth is no longer offset by government subsidies. Through reducing its bond-buying program and decreasing the flow of money by raising interest rates, the Fed will allow the recessionary tendencies to reveal themselves.

Those tendencies predated the pandemic, with historically high rates of debt, public and private, meeting historically low rates of investment.³ Low growth, once we subtract the part of the economy financed by the government, is a sign of low profitability: companies seek returns not just so their CEOs can buy yachts, but to invest those returns so the companies can continue to grow and compete. If they’re not investing, it’s because the profit outlook is dim. It’s the lack of investment, in raw materials, buildings, machinery, and labor, that shows up as unemployment and stagnant markets for both production goods and consumables. Since the Great Depression, governments, afraid of the social consequences of large-scale unemployment, have put money into the economic system by purchasing weapons, subsidizing business, and expanding welfare programs (or, in the US, the prison system) to make up for the inadequate growth of privately-owned companies. But since government money given away or spent on goods like jets, bombs, and jails has been taxed or borrowed from the private sector in the first place, this spending doesn’t do much for profitability. As a result, businesses must still compete among themselves for the diminishing pool of profit the system produces. Today they do this not so much by cutting prices, as in the past,. but by using political influence to win subsidies and by making use of market concentration to raise prices. (There are, for instance, only four chief meat producers in the US; none has an interest in pushing down the price of meat.) And if we look at society as a whole, inflation transfers money from workers as a group to employers as a group, because wages rise more slowly than commodity prices.

But inflation can become an inconvenience, eroding the interest collected by banks and the value of bondholders’ investments, while forcing businesses into an endless game of mutual catch-up. Then it can seem preferable to lower wages more directly by allowing the recessionary tendencies caused by low profitability to manifest themselves. This also furthers the concentration of capital, as smaller firms go under with rising interest rates. This is what was accomplished by the Federal Reserve under chairman Paul Volcker in 1980, complemented by the Reagan government’s attack on unions and welfare payments. (Similar maneuvers were carried out around the world, most notably in England under Margaret Thatcher.) The goal was not reducing federal deficits–in fact, the Reagan government tripled the federal debt– but concentrating the fruits of the economy in the hands of an increasingly restricted upper class.

It is no misunderstanding that leads Jerome Powell to evoke the precedent of Paul Volcker, calling him “the greatest economic public servant of [his] era.”⁴ Just as fifty years ago inflation was blamed on union power, today businesspeople and economists discover the threat of future runaway inflation in today’s faint stirrings of worker self-defense (the Great Resignation, unionization efforts), which have yet to make much headway against a half-century’s relentless attack on wages. “It’s a risk that we simply can’t run,” Powell, who has called the labor market “unsustainably hot,” (too hot for whom?) said at a news conference in May. “We can’t allow a wage-price spiral to happen.”⁵ The idea that the Fed’s liberation of recessionary forces is going to undo the inflation of rents, gas, and food relative to wages is laughable. The effects on people’s lives, however, will be no laughing matter.

Endnotes

1. Quoted in Stephen Gandel, “What to Expect as Corporate Giants Report Earnings for Fourth Quarter,” New York Times, January 14, 2022.
2. These remarks are quoted in Stephanie Kelton, The Deficit Myth (New York: Public Affairs, 2021), pp. 52–3.
3. See https://brooklynrail.org/2020/05/field-notes/Their-Money-or-Your-Life.
4. “‘I knew Paul Volcker,’ Mr. Powell said during congressional testimony this month. ‘I think he was one of the great public servants of the era — the greatest economic public servant of the era.’” New York Times, March 14, 2022.
5. Ben Casselman, “Making Sense of an Economy Running Hot,” New York Times, June 3, 2022.