[Congressional Record Volume 146, Number 30 (Thursday, March 16, 2000)]
[Extensions of Remarks]
[Pages E340-E342]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]


                 THE FED'S UNNECESSARY ASSAULT ON WAGES

                                 ______
                                 

                           HON. BARNEY FRANK

                            of Massachusetts

                    in the house of representatives

                        Thursday, March 16, 2000

  Mr. FRANK of Massachusetts. Mr. Speaker, I have become increasingly 
concerned that the relentless drive of the Federal Reserve to cut back 
on economic growth will lead to serious economic problems later this 
year. Federal Reserve officials have heretofore stressed that there is 
a time lag of many months between their decisions to raise interest 
rates and the effect those increases will have on the economy. We have 
recently had four Federal Reserve increases in interest rates, and by 
the Fed's own previous standards, only one of those could possibly have 
begun to have any economic impact, and that, barely so. For the Federal 
Reserve despite this to continue to raise interest rates threatens us 
with serious economic problems later in the year. I do not at this 
point believe that this will lead to a recession, although if the Fed 
continues to raise interest rates on a regular basis that will be the 
result. But what their actions will guarantee is a significant slow 
down in the growth of our economy. That is not only bad in itself, it 
will deprive our economy of the one factor that has served in recent 
years to alleviate the increasing trend towards exacerbating inequality 
that has accompanied overall prosperity for much of the past decade.
  The justification for the Federal Reserve's action is of course that 
it is necessary to stave off inflation. This is a justification the Fed 
offers, despite what might appear to be the inconvenient fact that no 
inflation is in prospect. In a recent analysis, Jeff Faux of the 
Economic Policy Institute analyzes the Federal Reserve's argument, and 
delves into American economic history to show the fallacy of the Fed's 
approach.
  Because of the importance of this topic to both the economic and 
social health of our country, and because of the cogency of Mr. Faux's 
analysis, I ask that it be printed here.

                 The Fed's Unnecessary Assault on Wages

                             (By Jeff Faux)

       The Federal Reserve Board has raised its key interest rate 
     a full percentage point since June 1999, and it has indicated 
     that it will continue to raise rates until economic growth 
     slows down.
       It takes a while for interest rate changes to work their 
     way through the economy. But sometime this year, the nation 
     can expect to begin paying the costs. These costs will 
     include: An increase in joblessness and a weakening of the 
     bargaining power of low- and middle-income families, whose 
     wages--after being stagnant for most of the 1990s--have been 
     rising in the last several years because of tight labor 
     markets. Higher housing, consumer credit, and general 
     borrowing costs. a worsening of the trade deficit, because 
     raising interest rates will increase the near-term value of 
     the dollar.
       According to Fed Chairman Alan Greenspan, these costs are 
     justified by the benefits of slower growth, which will: (1) 
     prevent the current boom from ``overheating,'' i.e., 
     generating politically unacceptable levels of inflation that 
     must then be brought down by engineering a deep recession, 
     and (2) deflate the overpriced stock market, thereby 
     preventing a future crash.
       But the slowing of the economy is unnecessary. As Greenspan 
     himself admitted in his February 17 semi-annual report to 
     Congress, ``inflation has remained largely contained.'' 
     Moreover, the historical evidence for Greenspan's 
     inflationary scenario is weak. As for an overpriced stock 
     market, the Fed has other policy options with which to 
     deflate it. These realities suggest that the Fed's 
     intervention has been aimed more at preventing wage increases 
     than at preventing inflation.
       If anything, lowering, rather than raising, interest rates 
     is a more appropriate monetary policy for the current 
     condition of the economy.


                          NO INFLATION SIGNALS

       There are no signs that the economy is approaching close 
     enough to capacity to represent a serious inflationary 
     threat. The latest data show that the January ``core'' 
     inflation rate--consumer prices other than volatile energy 
     and food prices--rose only 1.9% above the year before, 
     compared with a 2.3% annual increase a year earlier.
       Nor is there any evidence that production is threatening to 
     outstrip capacity. The Federal Reserve's own numbers show the 
     capacity utilization rate at 81.6%, substantially below the 
     85.4% reached in 1988-89, at the peak of the last business 
     cycle.
       The employment cost index--the statistic said to be most 
     watched by the Fed economists--in the fourth quarter of 1999 
     was rising at an annual rate of 4.5%. But productivity was 
     rising even faster--by 5%--leaving room in the economy for 
     more noninflationary wage increases.


                         THE DISAPPEARING NAIRU

       It is of course plausible that at some point spending could 
     outgrow the economy's capacity to produce, causing prices to 
     accelerate to unacceptable levels. Economists have labeled 
     the unemployment rate below which this inflationary spiral 
     would theoretically ignite as the NAIRU, or the non-
     accelerating-inflation rate of unemployment.
       In the early 1990s, the conventional wisdom among 
     economists, including most at the Federal Reserve, was that 
     the unemployment rate could not go below 6% without 
     triggering an accelerating rate of inflation. The few 
     economists who pointed out that there was little empirical 
     evidence to support this theory and that the economy could 
     achieve noninflationary unemployment rates of 4% or even 
     lower were derided by the profession and ignored by the 
     business media. (The late William Vickery of Columbia 
     University, a Nobel Prize winner, said in 1994 that a 2% 
     unemployment rate was feasible.)
       The unemployment rate has now been below 6% since September 
     1994, below 5% since June 1997, and below 4.5% since April 
     1998. As we have seen, core inflation has not only not 
     accelerated, it remains dormant.
       The experience has taught us that no one, not even Dr. 
     Greenspan, can calculate the

[[Page E341]]

     NAIRU beforehand. Moreover, it has discredited the notion 
     that low levels of unemployment will cause wages and prices 
     to accelerate out of control. The NAIRU is revealed as 
     useless as a guide to economic policy.


                        the wrong history lesson

       Still, the threat of the kind of runaway inflation that 
     caused such economic and political havoc in the 1970s has 
     been enough to stifle objections to the Fed's current 
     strategy, even in an election year.
       The inflationary terror with which Greenspan threatens us 
     is a scenario in which rising demand in a peacetime economy 
     bursts through the limits of capacity to set off a wage price 
     spiral that feeds on itself, becomes politically 
     unacceptable, and compels the government to bring it down by 
     engineering a recession (reducing demand by reducing 
     incomes). But, in fact, since 1914, when the U.S. began to 
     measure consumer prices with a comprehensive index, a demand-
     driven peacetime economic boom has never generated the kind 
     of inflation with which Greenspan frightens policy makers and 
     the public.
       A reasonable definition of ``politically unacceptable'' 
     inflation is a condition in which rising consumer prices are 
     used by the political opposition to successfully affect the 
     outcome of elections. In this sense, price inflation was a 
     significant national political issue on several 20th century 
     occasions. One was the aftermath of World War I, when war-
     time inflation continued to increase through 1920. Prices 
     rose 15% that year, and Republican Warren Harding, along with 
     a GOP Congress, was elected on a platform of a ``return to 
     normalcy.''
       The next was 1946, when the end of World War II's price 
     controls saw prices rise at a rate of 8.3% between 1945 and 
     1946. Rising meat prices were a particular sore spot with the 
     voters, who elected a Republican Congress that November. 
     Interestingly, prices rose at an annual rate of 11.3% over 
     the next two years, but Democrat Harry Truman was still re-
     elected in 1948.
       The next time that rising prices were a significant 
     political issue was in the early 1970s. World oil prices were 
     driven up by an oil-producing cartel, and a series of bad 
     harvests in Russia and elsewhere caused global grain prices 
     to rise as well. Price increases in these sectors then 
     rippled through the U.S. economy. Between 1972 and 1980, 
     consumer prices rose at an annual rate of 8.9%, and for three 
     of those years the increases were in double digits. Political 
     victims included Republican members of Congress decimated in 
     the off-year election in 1974, President Gerald Ford in 1976, 
     and President Jimmy Carter in 1980.
       Thus, the general price increases that have reached 
     politically troublesome levels have all involved several 
     years of sustained inflation at rates that at some point 
     reached double digits.
       If we take a 5% increase in the consumer price index (CPI) 
     as the point in which prices are moving toward this 
     ``politically unacceptable'' range, we find that in no case 
     since 1914 did price inflation reach even that level as a 
     result of a peacetime economy growing beyond its capacity to 
     produce. Every time the growth in the consumer price index 
     reached 5%, the cause was exogenous to the domestic economy, 
     i.e., war-related or energy and food price shocks emanating 
     from outside U.S. borders.
       Figure 4 shows the history of consumer price changes year-
     by-year since 1914. Working backward, the brief price spike 
     in 1990 that put the CPI slightly over 5% was a result of a 
     sharp, short run-up in oil prices during the Gulf War. As 
     indicated above, the inflation of the 1970s was not a result 
     of an overheated economy but was generated by world oil and 
     grain price shocks. Nor was the previous bout of inflation in 
     the late 1960s ignited by an insufficiently vigilant Fed; the 
     culprit was Lyndon Johnson's refusal to raise taxes to pay 
     for the Vietnam War. The inflation episode before that was 
     fueled by the Korean War. And, as indicated, the other two 
     bouts of inflation were the products of the 20th century's 
     world wars.
       In other words, the memories of inflation that give 
     political support to Greenspan's policy of raising interest 
     rates reflect past experiences that are irrelevant to the 
     present condition of the American economy. In fact, one 
     cannot find in modern history the inflationary scenario from 
     which Greenspan is presumably protecting us.


                   Dampening stock market exuberance

       Recently, the stock market has been deflating on its own. 
     Still, given the widespread casino mentality that pervades 
     the markets, it is not unreasonable to attempt to bring down 
     values more in line with economic fundamentals, i.e., the 
     growth of employment, incomes, and production.
       But it is not reasonable to undercut those economic 
     fundamentals in order to bring down a speculative bubble in 
     the stock market. Instead, the Fed should be trying to 
     achieve balance by contracting the stock market and letting 
     the productive part of the economy expand, gradually 
     substituting real for speculative value in share prices.
       Much of the recent overvaluation of U.S. stock markets has 
     been fueled by excessive credit. The share of ``margin debt'' 
     to the capitalization of the stock market is now at or above 
     the heights reached just before the 1987 market crash. The 
     ratio of margin debt to the gross domestic product (GDP) is 
     now double what it was at that time.
       A number of market observers, including financier George 
     Soros and Stanley Fischer, deputy director at the 
     International Monetary Fund, have recently advocated that the 
     Fed let air out of this credit boom by raising margin 
     requirements. But Asian Greenspan has consistently refused. 
     When asked about this at his confirmation hearing before the 
     U.S. Senate Banking Committee. Greenspan said that he did not 
     want to discriminate against individuals who were not wealthy 
     enough to have other assets against which to borrow in order 
     to play the stock market. Given that people who use margin 
     leverage to buy stock are typically wealthy by any reasonable 
     standard, this is a rather weak rationale for favoring higher 
     interest rate policies whose costs will largely be felt by 
     lower-and middle-income working people.
       To the extent that Greenspan is concerned about irrational 
     exuberance in the stock market, raising margin requirements 
     should certainly be the weapon of choice.


                      Wages--the Fed's real target

       Given the absence of inflationary signals, the lack of 
     historical precedent, and the Fed's disinclination to target 
     the stock market bubble directly, it does not appear that 
     preventing an outbreak of inflation--at least as most 
     Americans
       The Fed's defenders would of course argue that that is 
     exactly how one prevents ``wage-price'' spirals from taking 
     off. But as economist Jamie Galbraith has pointed out, every 
     episode of accelerating inflation since 1960, with the 
     exception of the lifting of Vietnam-era price controls after 
     Richard Nixon's re-election, were led by prices, not by 
     wages.
       The current effort to slow down the economy, therefore, 
     appears to be targeted at weakening the bargaining position 
     of labor vis-a-vis capital. Indeed, throughout this economic 
     expansion of the 1990, we have seen a shift of market incomes 
     from wages to profits. This shift has been so pronounced that 
     economist Jared Bernstein has calculated that, even if labor 
     costs were to accelerate to rising 1% faster than 
     productivity (as opposed to their current slower growth 
     rate), it would take four years before wages and profits went 
     back to their respective shares in the decade of the 1980s.
       It is reasonable to ask the following: if the expansion of 
     profits and the subsequent reallocation of income from labor 
     to capital that occurred throughout the 1990s did not by 
     itself raise inflationary concerns, why should a potential 
     swing back to labor's favor?
       The Fed is unlikely to enlighten us. But it is obvious that 
     Federal Reserve Boards have historically considered 
     themselves defenders of the interests of those who invest for 
     a living as opposed to those who work for wages. This one is 
     no exception.
       Greenspan deserves some credit for not having cut off this 
     current expansion when the unemployment rate reached what the 
     conventional wisdom assumed were NAIRU limits. On the other 
     hand, he has responded much faster to problems in financial 
     markets than to problems in labor markets. Thus, he was quick 
     to intervene in the economy in the case of the stock market 
     crash of 1987, the Asia financial crisis of 1997, and the 
     Long Term Capital Management debacle of 1998. But he was so 
     slow to react to a rising unemployment rate in the early 
     1990s that he allowed the economy to fall into a recession.
       Greenspan himself has said on several occasions that job 
     insecurity has been a significant factor in limiting labor's 
     earnings during the expansion and thus adding to profits and 
     the profit expectations that have fueled the stock market. 
     From this perspective, raising interest rates to raise the 
     unemployment rate, as opposed to targeting margin 
     requirements, insures that labor's share remains depressed 
     even as the financial markets are forced to undergo a 
     correction.


                      Keeping the Expansion going

       The economic policy task now facing the United States is 
     how to keep the current expansion alive by keeping it in 
     balance, e.g., avoiding speculative markets, excessive debt, 
     and high interest rates. This will require careful management 
     by both the Federal Reserve and the administration.
       First, at the very least, the Fed should not raise interest 
     rates any further. In fact, the Fed should gradually begin 
     lowering rates to keep probing the economy's limits and to 
     allow the dollar to fall and to make U.S. goods more 
     internationally competitive. If and when signs appear that 
     the domestic economy is overheating and price inflation 
     threatens, there will be plenty of time to raise interest 
     rates (or taxes) to reduce the growth rate.
       Second, at the same time, the Fed should use its authority 
     to raise margin requirements. In addition, both the Fed and 
     the Clinton Administration should move to reduce excessive 
     stock market and consumer credit use. Bank regulators should 
     discourage the growing issuance of unsound mortgage lending 
     and home equity loans and impose stricter regulation of 
     credit care companies.
       Tightening credit in speculative markets while allowing the 
     rest of the economy to grow will bring more balance to the 
     economy. In particular, it would help to raise real incomes 
     and at the same time help reduce consumer debt, providing 
     more stability and staying power for the household sector 
     that has been the sustaining force for growth over the past 
     decade.
       Third, neither the Fed nor the Administration should 
     attempt to slow economic

[[Page E342]]

     growth if energy prices continue to rise. The lesson from the 
     1970s is that oil price cartels do not last. It helps that 
     the U.S. economy is less energy intensive than it was in the 
     1970s and less vulnerable to energy price increases. The 
     president's decision to increase subsidies to help low-income 
     families to cope with temporarily higher heating oil prices 
     was wise. If necessary, the Administration should use 
     national oil reserves to counter any extraordinary short-term 
     surge in prices that threatens to cut off economic growth.
       This longest economic expansion in modern history has in 
     the last few years finally begun to bring real income growth 
     to low- and middle-income Americans. Maintaining that growth 
     is essential for America's private sector to remain 
     competitive and its public sector to have the revenues it 
     needs to finance social investment.
       The risk of jeopardizing these goals far outweighs any 
     small risk of a sudden and historically unprecedented 
     outbreak of demand-driven inflation.

     

                          ____________________