March 27, 1997
Houston Chronicle, March 27, 1997
Minneapolis Star Tribune, March 28, 1997
Chicago Tribune, April 6, 1997
Anyone who thought that the Fed considers the public interest when deciding on monetary policy was in for a rude awakening last Tuesday. With the Wall Street Journal reporting that Federal Reserve Chairman Alan Greenspan would “need a magnifying glass” to find any evidence of accelerating inflation, the Fed went ahead and raised interest rates anyway. The tens of thousands of people who will lose jobs as a result of this decision might want an explanation. Greenspan has provided one in his recent testimony before Congress. His fear is that a “continued tight labor market” would put upward pressure on wages, which might eventually cause inflation to rise.
To head off the “threat” of rising wages– which at least 80% of Americans would consider an opportunity rather than a threat– he has chosen to deliberately slow down the economy. This will, in the Fed’s reasoning, increase unemployment enough so that employees will have less bargaining power to demand higher wages.
Let’s ignore the perverse perspective for a moment and see if this analysis makes any sense even on its own terms. What does it mean to have a “tight labor market?” One sure sign would be rising compensation for wage and salary earners. But the employment cost index for 1996 rose only 2.8%, less than the 3.3% increase in inflation. It seems that labor markets will have to get a lot “tighter” before most employees have anything to show for this economic expansion.
And that is the heart of the problem, because today’s Fed will never let American labor markets get that tight. It is only because of an unusual combination of circumstances that Fed has even allowed the unemployment rate to drop to its current 5.3%.
Just two years ago the operating theory of the Fed– based on a mainstay of introductory economics textbooks– was that unemployment could not drop below 6% without causing inflation to rise. But the theory was overtaken by events, as the economy grew faster than expected. Unemployment has remained below 6% for 30 consecutive months without causing any upward pressure on prices.
Many of those months were too close to the Presidential election for the Fed to risk raising interest rates, for fear of the political attention that such a move would draw. So unemployment was able to drop below it’s so-called “natural rate,” and stay there.
The Fed’s contention that inflation is primarily caused by rising wages is also rather dubious. Historically, our major bouts with inflation have resulted from wars, oil price increases, and other external factors– not from employees getting overly greedy and winning unsustainable wage hikes.
Greenspan now admits that there is no “natural rate” of unemployment such that inflation would increase if unemployment fell below that rate. But these “tight” labor markets clearly make him uncomfortable, like an overly tight pair of pants.
Unfortunately he’s not the only one who breathes a sigh of relief when the unemployment rate goes up and gets indigestion when wages even manage to keep pace with inflation. The big bondholders feel exactly the same way, and it is their interests– to the exclusion of the rest of us– that dominate the Fed.
The Fed’s latest decision to raise interest rates makes this one-sided, plutocratic character of the Federal Reserve even clearer than ever. The only remaining question is whether they will continue down this road far enough to bring on the next recession. The economy has been growing for six str aight years now, and there is little evidence that this expansion phase of the business cycle is about to expire of its own accord. The Fed, however, can bring this process to a halt by continuing to raise interest rates, just as a scientist experimenting with laboratory animals can arbitrarily alter the circumstances of their survival.
How far they take this particular experiment remains to be seen. But as long as the Fed is preoccupied with its fear of “tight labor markets,” the majority of Americans will continue to see their real wages and salaries decline, as they have for the pas t two decades. This is part of the price we pay for allowing a handful of unelected, unaccountable officials to wield such unchallenged power over our economy.