The Fed is partying like it’s 1979

March 19, 2023 7:59 am

By raising interest rates, the Fed has been digging in on customary explanations and customary policy solutions. But these aren’t customary times. (Photo: Federal Reserve Board of Governors)

Working people in the U.S., and especially in Nevada, are not making too much money.

It’s tempting to say “This message was brought to you by Captain Obvious,” and leave it at that.

But there is much squawking that the Federal Reserve should hold off on raising interest rates again because that bank for the techy-techy kids went belly up and now the market, especially for bank stocks, is volatile.

There is just as much squawking that the Federal Reserve must raise rates as expected when it meets Wednesday because if it doesn’t it will make everyone think the Fed and its chair Jerome Powell are terrified that more banks will go belly up. The movements of the market-determining investor subculture being not unlike those of sheep, goodness we mustn’t spook them, lest they scurry en masse and knock over some financial minaret or other.

So don’t raise rates, and people will freak out. Do raise rates, and people will freak out. That reportedly is the conundrum facing the Fed.

Rather than concerning itself with startling flocks of investors, perhaps this would be a good time for the Fed to instead channel Jeremy Bentham and strive to achieve, you know, the greatest good for the greatest number.

Which would be not raising rates.

The reason the Fed should not raise rates is rate hikes are the wrong tool for the job and doing more harm than good. And not just to the techy-techy kids’ bank that made very large bad bets (which it was allowed to do because this is America, dammit, we don’t regulate banks.)

The Fed has a long, long history of being terrified that working people might start getting paid what they deserve, and if that happens, it’ll fuel inflation. The Fed has been raising interest rates on the premise that working people are just making too darned much money. Higher interest rates will slow down the economy, and then there won’t be as much demand for workers, so wages won’t be rising so much, and that’ll tame inflation. Or so goes the conventional wisdom, with which the Fed has always been enthralled.

The Fed is partying like it’s 1979. It’s been digging in on customary explanations and customary policy solutions. But these aren’t customary times. The initial major drivers of higher prices were not an overheated economy – to which (for better or worse) higher interest rates is the conventional prescription. The major initial drivers of inflation were Covid ripping ye olde supply chain to shreds, and Putin’s military aggression.

When inflation was roaring, wages weren’t rising enough to outpace it. But somehow corporate profits were.

Taking a charitable view, the practice of blaming rising wages for higher prices is the result of habit-formed speculation. A less charitable view of the argument that wage inflation is driving price inflation would be ohferchrissake get a clue.

Meanwhile, inflation has been slowing over the last several months, pretty aggressively in fact, for a combination of factors. Energy prices, which ripple through to so many other prices, have fallen. Supply chain bottlenecks and chokeholds have relaxed – for example, there are chips to put in cars which means there are more cars to sell which means there’s less pressure on car prices.

Housing prices have also fallen, which was a likely eventuality no matter what the interest rate given the irrationally exuberant increase in the cost of residential real estate in recent years. Over the last year, higher interest rates have contributed to the drop in housing prices, but also made mortgages more expensive, replacing one barrier to home ownership with another. And to whatever degree housing costs were ever driving the Fed’s interest rate hikes, Powell has made it clear that rising wages, not housing prices, is where the Fed’s head is now.

And while the Consumer Price Index rose 0.4% in February, “shelter” was still the largest contributor to that increase, despite the softening of the housing prices and reportedly a slowing of rent increases.

So to what measure can the Fed take credit for slowing inflation by raising interest rates? Consumer spending is still strong, so … maybe not much?

Wage growth is starting to show signs of slowing though. Inflation started simmering down long before and much more quickly than a slowdown in wage growth. That lag underscores that wage inflation wasn’t driving price inflation in the first place. And that in turn suggests interest hikes might end up lowering wages, needlessly, more than they lower prices.

Even more interest rate hikes will inevitably have a slowing effect on the overall economy, and just as inevitably exert downward pressure on wages. Somehow one suspects the downward pressure on corporate profits won’t be anywhere near as forceful. Less money for working families while capital continues to enjoy handsome profits – maybe that’s the sweet spot, the holy grail, the “soft landing” of which Powell and other white guys in ties speak so adoringly.

Workers found themselves a little empowered there for a while – a rare phenomenon in the U.S. economy of the last half century or so. Adjusted for inflation (which has continued to exist over the last few decades but rarely in banner headline form like the last couple years), those wages were either stagnant or falling over most of that time. It’s not like wages have increased in some dramatic fashion – to reiterate, they didn’t rise as much as inflation did. But they are higher. Alas, this is America dammit and evidently we can’t have that.

A version of this column was originally published in the Daily Current newsletter, which is free, and which you can subscribe to here.

Our stories may be republished online or in print under Creative Commons license CC BY-NC-ND 4.0. We ask that you edit only for style or to shorten, provide proper attribution and link to our web site. Please see our republishing guidelines for use of photos and graphics.