The chair of the Fed announced yesterday that interest rates will fall, and soon. So what? Why is low inflation bad for the economy, and why does it present a problem for the Fed’s Governors, particularly the Star Chamber we call the Federal Open Market Committee? Good questions. Keynes once quipped that rapid inflation “armed enterprise against accumulation” by devaluing existing assets and making repayment of loans easier for both entrepreneurs and consumers. In this as in so much else, he was right.
How so? The value of existing assets is enhanced by inflation that clocks below the Fed’s target rate of 2% annually. That enhancement dampens demand for credit from entrepreneurs, resulting in lower investment and innovation, presumably slower growth. It also encourages going concerns to stand pat, to hoard their cash, which compounds the prospect of slower growth and thus lowers everyone’s expectations. Meanwhile, debtors, especially consumers, can’t discount their loan obligations, by paying off loans in dollars worth less than they borrowed.
Moreover, if inflation is below target, what can cuts in interest rates cause? The real interest rate (adjusted for, uh, inflation) in large swaths of Europe and in japan is now at zero or below. It’s not far from that in the US. What can the Fed do the next time crisis strikes (and it will), if monetary policy is the only arrow in the counter-cyclical quiver? Adopt the so-called Taylor Rule in reverse, give away money when price increases are nil or turn negative? Well, yeah, that’s pretty much what “quantitative easing” means, and it’s more fiscal than monetary policy. But did it work, ca. 2009-15? Nah.
The Fed’s “dual mandate” is predictable price stability plus maximum employment, as per the Full Employment Act of 1946 and the Humphrey-Hawkins Act of 1978. Any dip below full employment rates (roughly 5%) was, in theory anyway, supposed to increase inflation rates by raising wages in tighter labor markets. So much for the theory. The official unemployment rate is below 4%, and wages are still flat (showing very slight improvement). Price inflation is at 1.6%.
In other words, the transfer of income from labor to capital that began in earnest with the Reagan tax cuts continues. What gives? Is there anything the Fed can do about it?
No, not yet. The distribution of income between capital and labor is a function of a very simple relation. When real wages–nominal income adjusted for price inflation–rise and productivity falls, capital’s share of national income is in effect expropriated by labor. That’s what happened in the late-19th century, during the so-called Gilded Age, ca. 1873-1896. If you doubt this proposition, see my voluminous proof in the American Historical Review vol. 92 (1987): 69-95. Labor won that phase of the class struggle, hands down.
And vice versa. That’s what has been happening since 1983: capital has been expropriating labor’s share of national income. Productivity has increased, fitfully to be sure, mostly in the 1990s–the current annual rate is 1.5%–but real wages have not. The Fed can’t do a goddamn thing about this situation, except to beg entrepreneurs to borrow for free (corporations don’t have to borrow: see Apple, GE, Amazon, et al.). It can’t help consumers who are paying 20% on their credit cards, and it can’t help students who are locked into loans at 7% and higher.
So, why the Fed, if it seems helpless in this deflationary circumstance? Because it represents the key principle of progressive America, viz., the market is to be managed for social purposes, not treated as an inviolable externality that guarantees “freedom” only so long as it remans untouched by human intentions. Because its mandate can be expanded by include the goal of equality, and can leverage member banks to seek it, especially in loaning in the real estate market. Because it can contain and discipline the predatory banks that have, by locating their credit card operations in South Dakota or Delaware, given vampires a good name.
Let the Congress have a say in appointing Fed Board members, in the regions and in D.C., with input from local bankers, of course, but also from city councils and social movements. Ways & Means, Finance, whatever, make it a joint committee.
Private control of bank assets makes no sense, not anymore, not on any rational grounds, because we the people bailed the vampires out in 2008, and because our taxes guarantee those assets through the FDIC.
Don’t take my word for it, see Willem Buiter, former chief economist at Citibank, and Mervyn King, former head of the Bank of England. They’ve been central bankers who know there’s no such thing as a safe bank (or investment), and that the financialization of advanced economies spells the end of the alchemy we call banking as such.
Here are the links you need. Today’s NYT, my review of King’s book, and the NYT article from May 21 that set me off.