“There’s a perception that unemployment is bad for people who lose their jobs but not for everyone else,” said J.W. Mason, an economics professor at John Jay College at the City University of New York, while “inflation hurts everyone.” But unemployment doesn’t remain siloed and is likely to hurt a lot more than the pinch of higher prices. As Dr. Owens put it, “It won’t be the case that this will feel like a light recession or it will feel like it was worth it to bring the price of milk down a dollar.”
The truth is that the Fed is operating with outdated and rigid ideas about the relationship between wages and inflation. In the decade after the Great Recession, wages grew, and unemployment recovered (albeit much more slowly than it should have) while inflation remained low. “The notion that there’s this exact one-to-one correspondence between wage growth and inflation really doesn’t hold up,” Dr. Mason said.
That’s because there are various ways that businesses can respond to the need to pay higher wages when workers have more bargaining power. The Fed apparently assumes that businesses will always pass the higher costs on as increased prices. But they could instead take a hit to profits — which have been robust in the rebound from the pandemic, in some cases thanks to pricing markups — and devote a larger share of profits to the workers who help generate them. It’s also possible for productivity to increase alongside wage increases, which will expand the economy and head off big spikes in inflation at the same time.
And yet the Fed’s response, kludgy as it is, is to raise interest rates, making it more expensive for businesses to invest, including in their work forces, which is ultimately supposed to stave off wage increases. If a recession causes unemployment, that also will keep wages from rising — because people who lose their jobs have no wages at all and those who don’t won’t have as much bargaining power to demand more. Federal Reserve officials “think that given the current mix of economic factors that they’re looking at, workers need to be on the chopping block,” Dr. Owens said. “They’re going to focus on bringing prices down in the way they know how, with their giant interest rate hammer.”
Since at least the wage-price spiral of the 1970s, the Fed has been “extremely focused on limiting the power of labor,” Dr. Mason said. In 1982, staff members at the Federal Open Market Committee celebrated the fact that “the prolonged period of slack labor markets has paid handsome dividends in an easing of wage inflation.” Paul Volcker, the Fed chairman who brought down double-digit inflation in the early 1980s by engineering recessions, famously carried around an index card showing the schedule of upcoming collective bargaining contracts, and he explicitly saw President Ronald Reagan’s breaking of the Professional Air Traffic Controllers Organization strike as a win in the battle against inflation. “Volcker was very clear that what he was doing required getting negotiated wage settlements down,” said Andrew Elrod, a research specialist at United Teachers Los Angeles who has studied the history of the Fed.
In a paper on the Fed’s policies with regard to unions, Daniel J.B. Mitchell and Christopher L. Erickson noted that when the Teamsters staged a strike against United Parcel Service in 1997, the president of the Federal Reserve Bank of Dallas, Robert McTeer, worried that the settlement they eventually reached would “go a long way toward undermining the wage flexibility that we started to get in labor markets with the air traffic controllers’ strike.”
And yet the Fed’s reasoning — that inflation must be tamed by taming the American worker — doesn’t fit neatly with our current economy. In part, that’s because this economy is warped by a pandemic that led to all sorts of unpredictable outcomes. Supply chain snarls drove up the prices of goods when they became scarce, and then price increases shifted to services as businesses abruptly reopened after abruptly shutting down, throwing everything into turmoil. The economy recovered pandemic-induced job losses at a remarkable clip, bringing unemployment to the lowest rate since 1969 in January, but that led to a temporary surge in demand. Working from home has changed rental markets for offices and homes. Russia’s invasion of Ukraine drove up energy prices.