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The Fed Should Stop

This piece was originally published in The Hill on October 17, 2022.


The Federal Reserve has raised interest rates five times in the last year and is committed to raising them twice more to slow the economy and bring today’s inflation down. It says it will continue down this path even though the International Monetary Fund (IMF), JP Morgan Chase and others are warning that these policies are likely to cause a recession in the U.S. and chaos overseas. Sadly, Americans have been won over many times in our history to versions of the Fed’s “tight money” narrative although tight money never comes out well for ordinary people. The power of this slow-growth narrative, like those of a TV serial, is that the episodes are based on familiar themes.


The Fed’s aim in raising interest rates is to reduce demand by limiting borrowing and credit. More expensive credit of course is a greater hardship for working people and small businesses with limited resources than for people and businesses with deep pockets. In the Fall of 2022, there are millions of Americans who will be hurt by higher rates and slower growth, but a strong counter-narrative to the Fed’s story has not emerged. While the monetarists have well-crafted lines that they repeat endlessly, there is no comparable pro-growth narrative. There could be because debates between advocates of hard money vs. growth were part of the bedrock of U.S. politics through the whole 19th and much of the 20th centuries. Today it is as if no one remembers William Jennings Bryan’s “Cross of Gold” speech in July, 1896 that is perhaps the most famous and passionate attack on scarce and expensive money and deflation. Also forgotten are the debates even earlier in our history pitting advocates of easy money vs. those favoring scarcer and more expensive money.


The Fed’s aim in raising interest rates is to reduce demand by limiting borrowing and credit. More expensive credit of course is a greater hardship for working people and small businesses with limited resources than for people and businesses with deep pockets. In the Fall of 2022, there are millions of Americans who will be hurt by higher rates and slower growth, but a strong counter-narrative to the Fed’s story has not emerged. While the monetarists have well-crafted lines that they repeat endlessly, there is no comparable pro-growth narrative. There could be because debates between advocates of hard money vs. growth were part of the bedrock of U.S. politics through the whole 19th and much of the 20th centuries. Today it is as if no one remembers William Jennings Bryan’s “Cross of Gold” speech in July, 1896 that is perhaps the most famous and passionate attack on scarce and expensive money and deflation. Also forgotten are the debates even earlier in our history pitting advocates of easy money vs. those favoring scarcer and more expensive money.


Unger described the pro-growth side in these debates when he noted that farmers and workers in the 19th century always wanted Congress “to supply money ‘adequate to the full employment of labor, the equitable distribution of its products and the requirements of business.’” Advocates for scarcer money, on the other hand focus on money itself rather than on money as a tool to mobilize America’s bountiful resources. The champions of hard money forced American farmers to pay in gold for government land in the 1830s and took paper money out of circulation after the Civil War, causing two long recessions. Prolonged periods of falling farm prices and deflation in the 1870s also linked to scarce money policies imposed hardship on urban as well as rural Americans, who joined to oppose such policies.


The alternative to a narrow focus on more expensive money (higher interest rates) to keep inflation in check is private and public investment to develop resources, lowering costs and the risks of inflation in this way. The Biden administration’s policies are decisively in this direction but the power of the familiar monetarist narrative makes many reluctant to criticize the guardians of hard money at the Fed.


The U.S. in the past had forceful advocates for public and private investment to lower costs and promote growth. Alexander Hamilton solidified American credit, bringing down borrowing costs to build lighthouses, canals, and promote advanced “manufactures.” The government gave land so that fast-expanding railroad networks could move goods more cheaply. The Lincoln administration in 1862 provided land to build land grant colleges to promote economic growth. New Deal investments in the 1930s and ’40s promoted development in the South and West.


President Eisenhower backed the interstate highway system. The government has financed many critical areas of research through DARPA, the Defense Advanced Research Projects Agency. Biden would like to create a national electric grid that would lower costs, develop alternative energy to break the grip of the OPEC cartel, deal with climate change, and increase energy security. Higher interest rates engineered by the Fed will limit this kind of investment and the opportunities it could create.


The Fed’s narrative today seeks to bolster support for raising rates by arguing that high rates in the late 1970s and early ’80s were needed to kill inflation even though they caused a sharp recession. What this does not recognize is that the economy from 1945 through the 1970s was vastly more inflation-prone than the economy today. John Kenneth Galbraith, President Kennedy’s economic guru understood why the earlier economy was more subject to inflation than today’s. He described a post-World War II economy in the 1960s that was dominated by price-setting companies and wage-setting unions that could push up prices and wages even when markets were soft. What Galbraith did not foresee was that these powerful industries and unions would be forced by Presidents Ford, Carter and Reagan and the Congress in the ’70s and ’80s to face much sharper price competition. Today because these sectors were opened to more intense competition, they have far less pricing power. Monetarists exaggerate the role high interest rates played in bringing down the inflation of the 1970s because they downplay or ignore the role that the policies of three presidents and Congress played in opening up important sectors of the economy.


What Galbraith called “administered prices” still exist in the energy sector (see OPEC +) where much of today’s inflation originated. Prices also are ratcheted up year after year by well-organized interests in health care, and the fix is in when it comes to executive compensation and higher education. Generally, however, inflation is far less likely to be a problem in the future than it was in the 1970s because very important sectors are opened to price competition.


This Fall, many prices that jumped in the past 18 months for COVID-19-related reasons are showing signs of softening. They will soften slowly and irregularly in today’s dynamic but unstable economic environment but they will soften because there is competition. Already, areas of softening include ocean shipping and trucking, lumber, computer chips, used cars, rents and housing prices in many areas, some foods, and some areas of the huge service sector. Retailers, for example, are starting sales early because they are overstocked and unfilled job openings are coming down.


COVID-19-related disruptions in China and elsewhere, the impacts of climate change, war in Ukraine, and OPEC+ still push prices up in some sectors but supply will catch up if the U.S. supports pro-growth policies that do not put us through a recession wringer. The Fed’s current approach to inflation aimed at choking down borrowing and demand is the wrong anti-inflation policy. Better policy and a better narrative would focus on competition and increasing production, challenging the dogma that calls for slower growth.