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Monetarist Recession or Targeted Approach to Inflation?

This piece was originally posted on The Hill on 9/7/2022. You can see that version here.



Federal Reserve Chairman Jerome Powell and his colleagues are continuing to raise interest rates even though they know this is likely to cause a recession. At the annual bankers’ gathering in Jackson Hole this August, Powell promised “pain” as a result of the interest rate increases he is engineering. Everyone knows this will be hard on working people, but the Fed policy makers seem to have made up their minds.


Why are they risking a recession and a serious increase in unemployment? Because the “idea” driving Monetarist economics these days is “credibility.” Deep down, it’s that sick machismo business again. The central bankers are persuaded that they have to have the “cohones” to cause a recession, or they will be seen as wimps and inflation will become “untethered,” that is soar out of control. Squeezing down on credit by raising interest rates is the price working people will pay to show that the Board is manly and unflinching.


This credibility fixation makes no sense. Prices in competitive markets are set by supply and demand not credibility or expectations. If a roofer demands $100 an hour because he expects that is where wages are going and there is another roofer competing with him for the business at $85 an hour, it doesn’t matter what the first person’s “inflationary expectations” are. If one car dealer asks $30,000 for a car and the dealer down the street will take $29,000, the first dealer’s “expectations” of future prices don’t matter. It was not the Fed’s credibility and willingness to cause pain that brought down inflation in the 1980s and 90s. It was the weakening of the OPEC oil cartel and a series of targeted pro-competitive reforms in key economic areas promoted by Presidents Ford, Carter, Reagan and congressional leaders that did the job.


This history is worth reviewing. The post-World War II U.S. economy was dominated by large corporations in key industries. Government regulatory agencies — the Interstate Commerce Commission (ICC), the Federal Communications Commission (FCC), the Civil Aeronautics Board (CAB), the Securities and Exchange Commission (the SEC), and antitrust laws were meant to limit the pricing power of these companies, but they weren’t fully successful during the ’50s, ’60s, and ’70s. President Carter recognized this as did Presidents Ford and Reagan so between 1976 and 1980 Carter appointed leaders at the regulatory agencies who wanted to promote competition to break the hold of the powerful incumbents.


The Federal Communications Commission (FCC) and the courts over a period of years ended Ma Bell’s (AT&T) communications monopoly, and communications costs dropped like a rock. The Interstate Commerce Commission (ICC) broke the power of regional rate-bureaus that set prices in trucking and ended “back hauling” limitations and other restrictions on trucking competition. The ICC and Congress then moved on to force the railroads to follow suit. Shipping costs dropped sharply just like the costs of communications services.


The Civil Aeronautics Board (CAB) allowed new freight and passenger airlines to enter and open up additional routes for the first time since the 1930s. FedEx in the freight area is a product of these CAB reforms which brought competition to air transportation.


The point here is that high interest rates engineered by the Fed in the late 1970s and early 80s had little to do with these anti-inflationary structural changes in communications, trucking, railroads, airlines and retailing although the Monetarists have never recognized this.


It was not just the “regulated industries” that were restructured to be less inflation prone in the 1970 and 80s. Pro-competitive actions by the government during this period also reduced prices in the huge manufacturing sector, which was not formally “regulated.”


The whole mid-section of the U.S. after World War II was dependent on the Big 3 car companies. Industries like steel, metalworking, and machine tools were tied to the three automotive giants. Inflation was tamed in this key manufacturing sector in the 1980s because the government did not yield to pressure to close the market to auto imports and new domestic automakers. Instead, GM, Ford and Chrysler were forced to compete with Volkswagen, Toyota, Honda, Mazda, Mitsubishi, Subaru, Audi, BMW and a raft of others.


Dealers wanted to sell these makes of cars too, so they fought to free themselves from exclusive arrangements with the Big 3, increasing competition at this level too. Monetary policy again was hardly a factor. The huge retail sector also was opened to more intense competition. Traditional mark ups between wholesale and retail were sharply reduced by competition from Walmart and other big box stores. Not surprisingly this held down prices no matter what the Fed did.


Monetarist policies — raising rates and squeezing down on credit for middle-class borrowers in the 1970s and 80s as the Fed is doing now — get far too much credit for taming inflation in that period. Higher interest rates and a deep Fed-inspired recession in the 1980s were not what opened up communications, transportation, manufacturing or retailing. It was the targeted actions cited above. In 2022, by the same token, higher rates will not lower prices of gasoline, natural gas, fertilizer and electricity or remove key bottlenecks which ought to be the targets of long-term government policy.


Pain-causing interest rate increases by the Fed are applauded because they look tough but don’t target the well established insiders. In reality they are a way to avoid the hard political work of tackling specific issues in energy, transportation, supply chain and climate, the areas that are driving inflation.