The Federal Reserve Board has signaled its intention to raise interest rates, citing fears of an overheated economy. Robert Reich published an opinion piece in The Guardian saying that raising interest rates will hurt American workers. Reich explains; “They fear that a labor shortage will drive up wages, which in turn drive up prices – and that this wage-price spiral will spin out of control.” Reich explains why this is wrong.
The theory behind the Fed’s action is called the Philips curve, which basically says that when unemployment goes up, inflation goes down, and vice versa, when unemployment goes down, inflation goes up. Here is a technical discussion of the history of the Philips curve. This one is shorter and may be easier to read. They both say the same thing: there is no obvious relationship. The first article describes some professional criticisms of the Philips curve which, unfortunately, never had an impact on the decision-making. The position of the economics profession is apparently that it must be right because they learned in an advanced economics course in college.
When you think about it, it’s complete nonsense: there are many sources of inflation, not the least of which is the pricing power of corporations. When most industries are highly concentrated on a few market players, they can set prices to maximize their profits. For example, Amazon dominates retail. They just increased the price of their Prime service by $20 per household. There are approximately 150 million US subscribers. This represents a revenue increase of approximately $3 billion. Amazon blames wage increases and inflation for the increase. Not really. It comes on top of a staggering $33.4 billion in profits. So there you get a huge increase in profits, far more than any salary increase or other inflationary cost.
Reich says the impact of Fed interest rate hikes will trickle down to American workers. As he puts it, “higher interest rates will hurt millions of workers who will be unwittingly drawn into the fight against inflation by losing jobs or raising wages for a long time.”
Let’s look at the numbers.
This graph shows the share of GDP devoted to labour*.
Gray bars are recessions. Almost every recession since 1947 has been triggered by interest rate hikes. This chart shows that when wages start to rise, the Fed raises rates, leading to recessions. The wage share is falling. When it starts to rise again, the Fed triggers further rate hikes. Prior to 1960, the labor share had almost reached its highest previous levels. After 1960, the peaks of the labor share never reach their previous level.
The Great Crash led to a recession, which was not caused by the Fed. In response, the Fed cut interest rates to zero. But the labor share only returned to 2008 levels in 2020 and has fallen since. Why does the Fed fear wages at this absurdly low share of GDP?
Now let’s look at corporate profits. This chart shows an estimate of corporate earnings**.
The chart shows that from 2012 to 2020, corporate profits were roughly flat at around $2.2 trillion. Then profits jumped to the current level of $3.1 trillion in just two years. I guess the total upside is something like $1.4 trillion. It’s an amazing increase. When has any media highlighted this as a major driver of inflation? Business journalists repeat claims from corporate PR hacks that it’s all the fault of greedy American workers, or Covid, or *** supply chains, and it’s just market forces at the moment. ‘work. Talking heads will tell us that gigantic oligopolistic corporations will use these profits to build new factories and increase supplies. Or another spiel from the Econ 101 textbooks.
1. The Fed protects capital at the expense of labor. That’s what we mean when we say inflation is such a big problem that we have to hammer workers with unemployment to hedge against inflation. It is true that inflation affects workers, but why is there no way to solve this problem by penalizing capital? After all, inflation due to corporate actions, such as supply chain, market power, rising prices and favorable government treatment, is just as dangerous as any inflation induced by wages.
2. Reich points out that there is no evidence of wage inflation. Quite the contrary. Workers have been pounded by Covid and aggressive union busting, and price gouging, and soaring health care costs and student debt. They haven’t caught up. He doesn’t say it, but the top quartile did pretty well, and the richer and richer the people, the better off they are.
3. Corporations have rigged the structure of the market so that workers are screwed. The government did little to help. Can you imagine Congress stepping in to help workers? They can’t even raise the minimum wage. How long will people endure this mistreatment?
* Here is the methodology. The number is a ratio, with all wages and salaries and owner’s labor compensation in the numerator, and what I consider gross domestic product as the denominator, all measured in constant dollars.
** Here is the definition.
Profits from current production, referred to as corporate profits with inventory value adjustment (IVA) and capital consumption adjustment (CCAdj) in the National Income and Product Accounts (NIPA), is a measure of net income companies before deduction of income tax which is consistent with the value of goods and services measured in GDP. The IVA and CCAdj are adjustments that convert inventory withdrawals and fixed asset depreciation reported on the basis of tax returns and historical cost to economic measures at current cost used in the National Income and Product Accounts . The profits of domestic industries reflect the profits of all companies located within the geographic boundaries of the United States. The rest of the world (ROW) component of earnings is measured as the difference between earnings received from ROW and earnings paid to ROW.
***David Dayen, editor of The American Prospect, has produced a terrific series explaining the supply chain breakdown. Hint: It’s not Biden’s fault.