Inflation hawks: The job killers at the Fed
from Dean Baker
Discussions of inflation and Federal Reserve Board policy take place primarily in the business media. That’s unfortunate, because these discussions can have more impact on the jobs and wages of most workers than almost any other policy imaginable.
The context of these discussions is that many economists, including some in policy making positions at the Fed, claim that the labor market is getting too tight. They argue this is leading to more rapid wage growth, which will cause more inflation and that this would be really bad news for the economy. Therefore they want the Fed to raise interest rates.
The part of this story that few people seem to grasp is that point of raising interest is to kill jobs. If that sounds like a bizarre accusation to make against responsible people in public life then you need to pick up an introductory economics text.
The story line there is that we get inflation if too many people are employed. There are all sorts of ways of making the story more complicated, and many people get PhDs in economics doing just that, but the basic point is a simple one: at lower rates of unemployment workers have more bargaining power and are therefore able to push up their wages.
If higher wages get passed on in higher prices then we see more inflation. If workers demand higher wages to compensate for higher prices then we will see still more inflation. Pretty soon inflation is jumping into the double-digits and then we have Zimbabwe-style hyper-inflation where our dollars become worthless.
The last part is only a modest exaggeration. The point is that the inflation hawks argue that we are on the edge of having a very serious problem with inflation and want the Fed to raise rates before it’s too late.
While the Fed cannot always boost the economy as much as it would like with lower interest rates and other policies, there is little doubt that it can slow the economy with higher interest rates. Higher interest rates will discourage people from buying homes or cars. It makes it harder to meet credit card debt payments and other loans obligations. Higher interest rates will also discourage investment. With less demand in the economy we will see less growth and fewer jobs.
And the numbers here are potentially enormous. If higher interest rates from the Fed prevented the unemployment rate from falling below 6.0 percent, and the economy actually could sustain a 4.0 percent unemployment rate as it did in 2000, we would be preventing close to 10 million people from getting jobs. In addition, we would be denying much of the workforce the opportunity to share in the benefits from economic growth in the form of higher wages.
For this reason, the debates on Fed policy should be splattered across the front pages and at the top of every news show. After all, debates that don’t involve even one percent as many jobs, like the reauthorization of the Export-Import Bank or the Environmental Protection Agency’s new rules on carbon emissions, are treated as huge employment issues. These other policies actually don’t matter much for total employment (obviously some people will lose jobs, and that is a huge issue for those people), but the Fed’s interest rate policy actually is a huge employment issue.
There is a recent precedent for this debate. Back in the mid-1990s, most economists believed that the unemployment rate could not get below 6.0 percent without creating serious problems with inflation. They wanted the Fed to raise interest rates to keep the unemployment from getting much below this level.
This group included the economists at the Congressional Budget Office (CBO). In 1996 it projected that the unemployment rate would be 6.0 percent in 2000. It also projected that the budget deficit would be 2.5 percent of GDP in 2000.
Federal Reserve Chair Alan Greenspan disagreed with this view. He saw no evidence of inflation and therefore was content to allow the economy to continue to grow and the unemployment rate to fall. As a result of his position as Fed chair and his stature, he got his way. The unemployment rate fell to 5.0 percent in 1997, 4.5 percent in 1998, and was 4.0 percent as a year-round average in 2000.
And instead of the deficit of 2.5 percent of GDP that CBO had projected, we had a budget surplus of 2.5 percent of GDP. This shift of 5.0 percentage points of GDP from deficit to surplus would be equivalent to $850 billion in today’s economy. That’s real money.
This means that if the inflation hawks had gotten their way in the mid-1990s, and the Fed had prevented the unemployment rate from dropping below 6.0 percent, millions of workers would have been denied jobs, tens of millions would not have seen pay gains, and we would have continued to run substantial budget deficits.
This is the situation we face today. Many in the financial industry couldn’t care less about unemployment. They don’t want to risk any inflation that could erode the value of their wealth. Their voices are being heard at the top levels of the Fed. It is essential that the broader public get involved in this debate as well.