October 12, 2022


Who Pays for Inflation?

A conversation on monetary policy, labor, and the definition of inflation

The inflation of the past year has reshaped the political economic landscape in the United States and around the globe. While the IMF and World Bank echo UN calls about the recession risk of globally-synchronized rate hikes, the debate over the causes—and definition—of inflation continues to be unsettled. As does the question of the politics of inflation and its distributional impacts—who benefits and who pays.

To clarify the foundations of these questions, Assistant Professor at the CUNY School of Labor and Urban Studies Samir Sonti spoke with Assistant Professor of economics at John Jay College JW Mason. The conversation was conducted for the New Labor Forum’s “Reinventing Solidarity” podcast, and a recording can be viewed here.

This transcript has been edited for length and clarity.

A conversation with JW Mason and Samir Sonti

SAMIR SONTI: For a long time, I have been preoccupied by the way the politics of inflation affect working people. There is hardly anyone I’ve learned more from about this subject than Josh Mason. To kick us off, it might be helpful to get some basic definitions on the table. Headlines tell us that inflation is at a forty-year high, but for working people, a rising cost of living is nothing new: house prices, for instance, have been climbing for years. Could you explain what precisely we mean by the term inflation? What distinguishes the recent inflation we’ve experienced from some of these other trends?

JW Mason: The definition of inflation that people are most familiar with is a period of rising prices. But as you pointed out, that immediately invites the question: which prices? There are many prices in the economy, and they do not all move in lockstep. When we look at inflation, we’re measuring the average price of things that a representative household buys. But this, again, invites a question: Which household? Different people buy different things, and the average prices of some goods are difficult to calculate. There is no such thing as “the price level” out there in the world, just various ways of constructing it.

In general, when we measure inflation we look at goods and services that people use. We’re not including stocks, cryptocurrency, interest payments, and other financial assets. But we’re also including some things that aren’t goods and services. For instance, the biggest single item in the consumer price index is what’s called “owners equivalent rent.” This is not a price that anyone pays—it is an estimate by the Bureau of Labor Statistics of how much it would cost a homeowner to rent their home, and computing it is a fairly complicated process. 

You’re absolutely right that housing prices are a longstanding problem in the US. But that is not necessarily captured in the inflation statistics, because most people in this country are homeowners, and coming up with a measure for the prices that they’re experiencing is not straightforward. Healthcare is another interesting case. Our statistics are constructed on the assumption that people consume things they buy for themselves, but much of our economy is more socialized than we usually recognize. We call healthcare a form of consumption, but most of the actual spending is by an employer or a government, not by the person getting the care. So when we talk about the “price of healthcare,” do we mean the price paid by families or the price received by providers? If you’re talking about bread, or plane tickets, it doesn’t make much difference, but in this case they can be very different. So the answer is not straightforward.

The Consumer Price Index (CPI), the measure of inflation that gets the most attention, has gone up by over 8 percent in the past year. However, there is also the personal consumption expenditure deflator, which is traditionally favored by the Fed, and which doesn’t always move with the CPI. Today, inflation measured by the PCE is significantly lower (something like 6 percent). It’s not obvious that one is more accurate or relevant than the other.

What we should take from all this is that inflation is not just a fact, it’s a statistical construct which involves many assumptions and choices. Depending on how you navigate those, you may end up with very different numbers. This also means that the ideas like inflation always increasing with excess demand or spending don’t really line up with the numbers we generate. Economists like to imagine that the thing we calculate is the same as the concept we derived in theory, but in a lot of ways they exist in different universes. 

That said, it is true that a lot of prices are going up. They are doing so in different ways, and perhaps for different reasons. Rental housing prices have been increasing more rapidly than the general price level since 2015; we don’t have enough housing in the places where people want to live, and most places don’t have any sort of regulations that would limit landlords ability to jack up rents on the housing that does exist. Then you have things like energy and food, which have also been rising quite a bit over the past year. Gas prices are the image of inflation everywhere—every article you read about inflation has a picture of a gas pump next to it. But the thing about those prices is they fluctuate a lot. They go up and they go down. Current gas prices are roughly the same as they were in 2014, and they were actually somewhat higher in 2008. 

One thing that is new in the past year or two is the rising price of manufactured goods—cars, very visibly.  Those are prices that, by and large, have been falling for quite a long time. Our global capitalist economy really does constantly improve its capacity to produce manufactured goods, and businesses are very good at sniffing out cheap labor to produce them. So the fact that these prices are now rising is arguably the piece of the current situation that is genuinely new. 

The important thing is to pay attention to each of these stories and not lump them together under one big umbrella of inflation.

SS: Let’s focus on that piece that is new. The Biden administration has attributed many of these price increases to supply chain disruptions. Critics argue that they are the result of the administration’s stimulus programs. What are the stakes of this debate, and what exactly is going on?

jw: We’ve got these competing stories: one about supply, the other about demand. In some ways, these are the same story, just told from different perspectives. You could say the price of a good is increasing because people want to buy more than businesses can produce, or you could say that businesses can’t produce as much as people want to buy. 

But differences do emerge when you think of these narratives more closely. We tend to think that the productive capacity of the economy rises steadily over time, which historically has led to the conclusion that if prices start rising more rapidly, that’s probably about something that’s happened to demand rather than to supply. Because normally, we don’t have big changes in our ability to produce stuff, while the amount of money that people want to spend can change quite rapidly.

Well, that’s generally true, but not always. Because of course, in this moment, we’ve had a very clear disruption in our ability to produce and transport goods. 

It’s a bit puzzling when you listen to Larry Summers, Jason Furman, and others on that side of the debate. They talk as if the only thing that has happened over the past three years is that the federal government suddenly started spending more money. And that’s true, it did. But something else happened too. It was called the global pandemic, and it was kind of important. Auto prices, to take one example, have increased dramatically not because people are buying more cars than they were a few years ago—they are not—but because at the onset of the pandemic manufacturers didn’t think they’d be able to sell any cars and stopped ordering semiconductors. Once you’ve halted demand for these specialized electronics it’s difficult to turn them back up again. So auto production collapsed and imported cars from the rest of the world could not fill the gap. Which is why, when people turned out to want to buy cars after all, prices went up. You can tell similar stories with other goods, it’s not so mysterious. 

The war in Ukraine has also boosted energy and food prices. There has been some interesting research recently about the importance of energy for broad based inflation. Energy is an input for almost every kind of industrial process, so its impact on broader prices is much bigger than that we see if we consider energy prices in isolation. 

Moreover, if we look at GDP trends from these past few years, we can see that prices were already going up even when demand was still well below the pre-pandemic trend. So I think if we’re arguing between supply and demand, it’s just unambiguously the case that the supply story is correct. In the absence of the pandemic, the level of spending over the past two years would not have produced anything like the inflation we’ve seen. 

That said, we shouldn’t deny that, given the pandemic, if we had had less spending in the economy, we probably would have had less inflation. But that doesn’t mean it would have been a better outcome. If we think back to the sense of economic doom that characterized the early part of 2020, we should also be grateful that we seem to have avoided the predicted economic catastrophe, even if it was at the cost of somewhat higher inflation. 

One example: The fraction of households who the US Department of Agriculture describes as suffering from “very low food security,” meaning that people literally are not getting enough to eat, is roughly 4 percent, in that worst category. In 2007, it shot up by 50 percent in just a couple of years, from 4 percent to 6 percent. That’s still a small percentage, but there are many more kids going to bed hungry every night. That was because of the financial crisis and its mismanagement by people like Larry Summers, who worried about over-stimulating the economy. We didn’t make that mistake this time around—we actually spent enough money to fill the economic hole created by Covid-19 and maintain people’s incomes. And as a result, the number of hungry people just went down. 

That is wonderful news. It also means that people have more money to spend than they would have in the alternative scenario. Yes, if there had been a massive wave of evictions, rents might be lower today. If enough people were going hungry, food prices might be lower. So if you want to blame demand, you can. We would have still had inflation due to prices imported from abroad, but we would have had less. That, however, is a different claim than the one that high demand is the reason we have any inflation in the first place. In any case, what we cannot lose sight of are the tradeoffs. Perhaps we could have had several points less of inflation, but how many hungry children is that worth? How many shuttered businesses? How many people were kicked out of their homes? That is the conversation that isn’t really happening, but should be.

SS: Let’s talk about the Federal Reserve a little bit. Thus far, the principal response to the inflation that we’ve seen has been higher interest rates, and all indications suggest that we can expect this to continue. So firstly, can we just establish what the Federal Reserve is? And second, why is it raising interest rates given everything you have said?

jw: The Federal Reserve is the central bank of the United States. It’s the institution that sits at the apex of the financial system. Today, it’s basically just part of the federal government; historically, it occupied a more ambiguous position with a greater relationship to private banks. It’s actually an interesting story. In the nineteenth century, the US didn’t have a central bank. One of the demands from the left end of the political spectrum—the populists in particular—was for a public institution which could manage the currency, and stop the periodic crises that resulted from the unmanaged gold standard. The Fed is in many ways the compromising response to that. Of course, the question of democratic accountability is a problem. But we should remember that we do want an institution to manage the financial and banking system. The problem is that we’ve also tasked that same institution with managing the macroeconomy, which it is not very well suited to do.

As for the interest rate—the idea is that you have an overnight rate that banks charge one another. This is a twenty-four-hour loan which allows banks to settle their accounts. The rate you pay on that loan is called the federal funds rate, and that is effectively set by the Federal Reserve. Since the 1990s, we’ve relied on this one interest rate to manage everything from economic growth to inflation and unemployment. It’s a bit crazy if you think about it. Despite what most people think, the legal mandate of the Federal Reserve is not to manage inflation and unemployment. Their mandate is to stabilize the long-run growth of money and credit, in a way that’s consistent with price stability and full employment. It’s an important distinction. It means that instability arising from the banking system ought not to be the responsibility of the Fed. 

In any case, the idea is that if you raise the interest rate, banks pay more to borrow from each other. Consequently, they will charge more for other kinds of loans, and in particular they will charge businesses more for borrowing to make investments. Less investment spending means less demand in the economy, less spending, and less employment. (Businesses hire people to make stuff, so if they’re making less stuff, they hire fewer people). When there’s a lot of unemployment and few jobs, wages also go down, which then flows back into lowering prices. That is the story. And in fact, Jerome Powell has been pretty up front about controlling inflation by forcing workers to accept lower wages. 

From our perspective, we might ask two questions about that. First, does it even work? And second, is there some better way to accomplish the same end? I personally think it doesn’t work very well, and we definitely could find alternative ways of solving this problem. 

The fact is, when you ask business owners how they make their investment decisions, the interest rate doesn’t figure prominently in their calculus. And on the other end, the labor market is changing for many other reasons. High unemployment leading to lower wages are probably the most solid element of the chain I’ve outlined. But the next step is much shakier—we know that prices don’t just move in lockstep with labor costs. If that were the case, the share of income going to wages would never change. So almost every step in this chain is pretty questionable. 

If we look at the statistical evidence based on the Fed’s own models, we see that the interest rate does have an effect, but it takes about two years to see it at its peak. So when they’re raising interest rates now, that may reduce spending and employment sometime in mid to late 2024. By that point, we might well be in a recession. If you’re trying to steer a car on a highway and you’ve got an enormous lag between when you move the wheel and when the vehicle actually changes direction you’re probably going to crash. 

On the other hand, the potential ineffectiveness is also a reason for optimism. Last time the Fed raised interest rates was in 2015, and there was no noticeable effect on anything. To be sure, if they raise interest rates enough, they can create a crisis, especially from people and the government paying higher rates on their existing debt. But if they don’t raise them high enough to provoke a crisis, it’s not clear they will have any effect on the real economy at all. The idea that the Fed by tweaking this one interest rate can steer the whole complex economy—this enormous division of labor with all these different decision makers—doesn’t have a lot of historical or statistical support.

SS: At this stage, we are seeing interest rates increase, but the actual number is still quite low (we may go up to 4 percent, but in the 1970s it was 20 percent or so). Before this, interest rates had been kept very low for many years, which raised issues of its own. Critics point to 2009-10 and the reliance on quantitative easing, which fueled Wall Street speculation on financial assets, introduced all kinds of new risks into the economy and intensified economic inequality. You’ve got a more nuanced take on this.

jw: My personal view is that the impact of quantitative easing has been overstated for good and for ill. The idea behind quantitative easing is that the Fed puts more money into the economy by buying bonds. But in the modern economy, “money” is a very amorphous thing. Many different assets can serve as money, and the Fed has no monopoly on their creation or destruction. When you give a bank however many billion dollars of reserves in exchange for the same amount of government bonds, you haven’t necessarily done much of anything, because those bonds essentially operate as money already. There is very little difference between the asset that the Fed is buying and the money that it’s paying for it. So the impact is going to be pretty negligible.

In the immediate aftermath of the 2007 crisis, when they were buying the bad assets that banks didn’t want and couldn’t sell, that was a different story. But the policy that people usually mean by QE, which is buying government bonds, is just swapping one safe, liquid asset for another. It’s like taking a bucket and moving water from one end of the swimming pool to the other.

On the issue of asset bubbles, I think low interest rates do lead to higher asset prices in general, but I’m not sure they reliably lead to asset bubbles. Bubbles take some other ingredients. If we look historically at the major disruptive asset bubbles, they weren’t necessarily in periods where interest rates were especially low. Interest rates were not particularly low in the late 1920s, in fact, they were quite high at the peak of the stock market bubble. Arguably, that was part of the problem, as high interest rates shift more activity into the bubble. If interest rates rise from 3 percent to 6 percent, that might discourage people from starting a business or buying a home. But the people buying stocks because they expect them to go up by 10 or 20 or 30 percent in the next year, they don’t care. 

I think if we want to blame the Fed for bubbles, we should focus on the fact that it doesn’t do its job of supervision, it doesn’t effectively manage the banking system. That should include an element of oversight and inquiry into what kind of assets banks are holding and what their terms are. We don’t need high interest rates to manage bubbles, we need a better regulated financial system. 

SS: Finally, what does all this mean for working people? And how should those of us committed to political and social change respond?

jw: There are three broad answers to that. The first is that we want to respond to inflation in a way that supports our larger agenda. We don’t want to talk about overspending, partly because it is wrong, but also because it supports an agenda of austerity which we don’t want. We don’t want interest rate hikes, not only because they don’t work, but also because we don’t want working people to bear the cost of the crisis even if they did work. 

The supply-chain narrative is therefore important because it implies that the solution here is public investment. If we don’t have enough port capacity, we need to build more port capacity. If energy prices are swinging all over the place, we need more investment in green energy and green jobs. If housing prices are going up, we need to build more public housing.

Second, we can’t forget that the Fed is trying to raise unemployment and lower wage growth. That is what interest rate hikes are intended to do. Our demand on the Fed should be very simple: don’t do that. We don’t need some complicated bank shot with conditions attached to bank bailouts, or anything like that. We just want the Fed to stop what it’s doing. We don’t want unemployment to go up. We don’t want wage growth to be slow. We don’t want it to be harder to find a job. We think a good economy is one where workers have an easy time finding a job, and businesses have to scramble to find workers. It’s good for working people, but it’s also good in the long run for productivity growth. It’s good for democratizing the workplace, it’s good for innovation. It’s good, and we want it, and we want the Fed to stop messing with it. 

Third, we can’t get distracted by inflation. Inflation is not the only thing happening in the world. Another important thing happening is that we have very tight labor markets, which make it easier for workers to bargain with employers. That’s why people are organizing at fast food restaurants and Amazon warehouses—not the only reason, but it’s very favorable terrain to be fighting on. 

One thing I’ve often heard from organizers is that you don’t need to tell people that, as we used to say at Occupy Wall Street, “shit is fucked up and bullshit.” They know that. Everybody knows what’s wrong with their job. What you have to convince people of is that they can do something about it. We shouldn’t lose sight of the fact that the current economic moment is one that is favorable to efforts at confronting our bosses collectively and individually. We don’t want to miss this opportunity. 

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