The Last Days of Sound Finance

Engine of Inequality: The Fed and the Future of Wealth in America
By Karen Petrou
Wiley, 2021

When the Federal Reserve turned to unconventional monetary policy in 2008, many feared that we would soon see a return to the wage-price spiral of the 1970s. The combination of deficit spending and monetary ease raised the old specter of debt monetization, in which the Treasury sells its debt directly to the central bank instead of the bond market, thereby freeing itself from interest obligations and market discipline. (Pejoratively, this is referred to as “printing money.”) But while quantitative easing (QE) did involve the mass purchase of Treasury bonds by the Federal Reserve, the Fed was buying these bonds from private financial institutions, not from the Treasury itself. Instead of opening a direct line from the central bank to the Treasury (a public—and, in theory, democratic—entity) , the Fed’s “money printing” operation detoured around the Treasury to create new reserves on the books of primary-dealer banks.      

This was, at best, an indirect form of debt monetization. But inflation hawks nevertheless turned to the well-worn scripts of the 1970s to make sense of what was happening. By driving down interest rates on future government borrowing, they warned, QE would encourage wanton social spending and release workers from the discipline of the market. Wages would inevitably be driven upwards at the expense of profits.¹ They need not have worried. Beginning with the Troubled Asset Relief Program or TARP, which bailed out private financial institutions while leaving indebted households underwater, post-crisis fiscal stimulus has prevented a collapse in consumption but done little to offset the astounding concentration of wealth and income at the top.² For all these reasons and more, the Fed’s decade-long (and counting) experiment with the money printer has failed to resurrect the wage-push consumer-price inflation of the early 1970s.³

When advocates of economic expansion proclaim that “this is not a return of the 1970s,” it is meant to be reassuring. But should it be? Arguably, the late 1960s and early 1970s represented the most effective challenge to wealth concentration in the long twentieth century and the closest the United States has ever come to fiscal revolution.⁴ By contrast, unconventional monetary policy, even when it has lowered unemployment, has only intensified inequality. Instead of wage inflation, we got asset-price inflation and, following the worldwide supply shocks of the coronavirus pandemic, stand-alone consumer price inflation. Not downward but vertiginous upward redistribution. Economic historians have commonly argued that pandemics, wars, and other exogenous shocks tend to empower labor and compress income disparities.⁵ This prognosis was not borne out during the coronavirus crisis, when central banks around the world reprised their large-scale asset purchases and predictably drove asset prices to new heights. Between the first quarter of 2020 and the second quarter of 2021, the top 1 percent of US income earners averaged net-wealth gains of $3.5 million per person, compared to $5,300 among the bottom 50 percent.⁶ The picture is even more disturbing when we consider that one in five Americans is a lifetime renter. With the end of coronavirus moratoriums, the rapid inflation of property prices has left millions of households (disproportionately minority and female-led) faced with escalating rents and eviction.⁷ Just when catastrophic weather events are becoming a fact of life, basic shelter has turned into a luxury good. 

The last three chairs of the US Federal Reserve have been loath to acknowledge any link between unconventional monetary policy and soaring inequality. Other central bank officials have been surprisingly forthcoming. In 2012, an anonymous report in the Bank of England’s quarterly bulletin admitted that rising asset prices had overwhelmingly benefited the top 5 percent of households due to their disproportionate share of financial assets such as stocks and bonds in their wealth portfolios.⁸ Although more evasive on the question of their own responsibility, both the Bank’s former Governor Mark Carney and former Chief Economist Andrew Haldane have recognized the role played by QE in exacerbating extreme wealth concentration.⁹ Others—including in-house economists at the Federal Reserve and Bank for International Settlements—have added their voice to the chorus, while in the meantime a handful of academic economists have undertaken the slow work of demonstrating the causal connections between ultra-low interest rates, central bank asset purchases, and the swollen asset portfolios of the wealthiest households.¹⁰

Asset-price strategy

Taken as a whole, this literature is damning in its assessment of institutional failure on the part of central banks and fiscal authorities. Yet for the most part, it lacks the panoramic scope that would propel it forcefully onto the public agenda. Karen Petrou’s Engine of Inequality is the first monograph to systematically investigate the distributive impact of the Federal Reserve’s unconventional monetary policy and to do so with the explicit aim of advancing alternatives. Although closely engaged with a dauntingly technical literature, the book is eminently accessible to a wider reading public. This makes for an enormously important contribution to the debate on wealth concentration and its institutional drivers.

Petrou aptly describes the Fed’s large-scale asset purchases and ultra-low interest rates as a kind of “trickle down” monetary policy. In theory, lowering the price of money is intended to encourage banks to step up their lending to households and businesses, whose higher risk profile would otherwise have deprived them of access to credit. In turn, this new lending would enable an expansion of personal consumption and business investment, both of which would generate new employment across the economy. Things did not turn out as planned, however. Instead of channeling liquidity downwards, banks have proven highly reluctant to lend to low- and moderate-income households. Credit flows to the business and corporate sector have privileged financial investments like share buybacks and private equity deals, whose main purpose is to bid up stock prices. If this is “supply side” policy, it is only in the sense that it has expanded the supply of credit in the service of asset price appreciation. There has been very little increase in the kind of long-range capital investment that would favor high-wage employment or empower workers. While the downward trickle failed to materialize, high-end portfolios have continued to appreciate. As a loose supply of credit bids up the price of financial assets, the benefits flow to those who hold relatively more of their wealth in the form of stocks, private equity, and the like.

Where some see unintended consequences, Petrou reminds us that raising asset prices was the Fed’s explicit goal. Four years into QE, Ben Bernanke still counted on “declining yields and rising asset prices” to “ease overall financial conditions and stimulate economic activity” across the board.¹¹ Petrou rightly traces this doctrine back to former Federal Reserve chairman Alan Greenspan, who from the mid-1990s to 2006 presided over a historic boom in asset prices. The foundation of the boom was the so-called “Greenspan put,” an implicit guarantee that the Federal Reserve would protect asset markets from downside risk, thereby assuring wealth holders that their portfolios would appreciate. Though he shared the central banker’s traditional hostility to wage inflation, Greenspan saw asset-price inflation as benign.¹⁴ Greenspan sat back and let “worker insecurity” do the rest. Labor figured in his political calculus only to the extent that workers might also become asset owners. If everyone could own (or aspire to own) a home, workers would be less inclined to fight back against stagnant wages.  

This democratic twist on the asset-price strategy—always problematic—is no longer on the table. Homeownership rates fell by more than 5 percent following the subprime crisis of 2007 and house prices are now out of reach for middle-income earners in many major cities. As Petrou demonstrates, low-cost bank credit has become even less accessible to so-called “subprime” households, despite the trillions of QE intended to stimulate such lending. Even with historically low interest rates, the income- and asset-poor have become ever more dependent on credit cards and extortionate payday loans.

A limited toolbox?

Petrou is illuminating on the distributional impacts of unconventional monetary policy. Her proposals for exiting the impasse, however, are less convincing. She argues that we need to act hard and fast to halt the momentum of asset-price inflation, insisting that the only tool we can count on is monetary policy. If the Fed created this mess in the first place, then only the Fed can get us out of here. Thus, she sees the unloading of the Federal Reserve’s bloated balance sheet along with a steady rise in interest rates as the best medicine for the job. By contrast, she flatly dismisses fiscal solutions including a wealth tax, an increase in federal spending on education and social welfare, or a federal infrastructure program. For Petrou, all such interventions are futile given the longueurs of the budgetary process and the inertia of the existing system of government transfers.      

Given the crushing disappointment of Biden’s first year in office, it is easy to see why pragmatically minded reformers might want to abandon the fiscal toolbox altogether. We live in a time where even the most conservative Keynesian maneuvers look wildly utopian. So, realists retreat to the technical fixes of central bank monetary policy as the easiest way out. Petrou’s failure to envisage a more ambitious public-spending agenda is motivated by more than pragmatism, however. At one point, she rejects any “overtly redistributive proposal” for equalizing wealth on the grounds that it “would hurt what’s left of the US middle class.” Elsewhere, she resurrects the classic “crowding out” thesis, once beloved by fiscal conservatives. In a curious inversion of the formula that once saw government deficit spending as crowding out private investment, Petrou contends that “increased federal deficits [have] destroyed public wealth” (emphasis added). Supposedly, “the more the deficit grows, the less net wealth US taxpayers collectively own and thus the less there is not only to go around, but also to devote to progressive policies.”  The logic is unclear, even incoherent: why can’t deficit-financed public investment increase public “wealth”? Moreover, accounting principles mean that a government deficit must correspond to a surplus on some private balance sheet—the opposite of the negative-sum conflict imagined here. Petrou seems unaware or unconcerned that recent experience (ten years of post-financial crisis deficit spending, followed by lavish if temporary public spending during the coronavirus crisis) has powerfully refuted old orthodoxies.

If Petrou’s implied point is that elite reactions to deficit-spending will vary depending on how (and for whom) money is being spent, she is right. Budget constraints reflect the struggle for power, not the implacable force of supposed economic laws. But Petrou seems genuinely, even quaintly, devoted to financial conventions that few others are following. Like Bill Clinton, who cast the New Democrats as Eisenhower Republicans fighting the excesses of Reagan Republicans, Petrou is a center-leftist stubbornly attached to yesterday’s conservatism. Having outlined QE’s outrageous transgressions of the rules of sound finance and its contributions to inequality, she shows little appetite for breaking those same rules on behalf of redistribution. She rejects not only Modern Monetary Theory (MMT), which sanctions permanent debt monetization, but even “helicopter money,” the more limited form of emergency central bank money creation advocated by Milton Friedman and (at one point) Ben Bernanke.  

This leaves Petrou with a slim set of monetary and regulatory options to choose from. Ultimately, she looks to monetary tightening and fiscal restraint to rein in asset prices and replenish the savings accounts of a rapidly receding “middle class.” Yet she does not explain how low- and middle-income households—already “struggling to manage day-to-day consumption”—can simultaneously maintain their living standards, increase their savings rate, lose access to consumer credit, and face higher interest charges on existing debt. The fact is that monetary policy alone is impotent to address the gross inequities of our time unless the fiscal levers of spending and taxation are also put into play. As Gerald Epstein and Juan Montecino remark, the paradox of our current conjuncture is that “both loose and tight monetary policy are likely to be disequalizing.”¹⁵ Given this dilemma, a lack of “utopian” vision turns out to be a practical liability. Absent a more imaginative fiscal politics, Petrou can only offer up a progressive version of sound finance. 

Abandoning “shared growth”

Petrou’s call for tighter monetary policy has now been answered by Jerome Powell’s Federal Reserve, which in July 2022 hiked interest rates by three quarters of a point, the highest percentage in decades, for the second month in a row. This policy turn represents a fatal misreading of the economic landscape. The current run up in consumer prices is driven by the supply-chain bottlenecks of the coronavirus pandemic, the Russian invasion of Ukraine, and profit-push price hikes on the part of business—not a return to the wage-price spiral of the 1970s.¹⁶ A rise in interest rates will do nothing to resolve these supply-chain issues and will certainly not help low-income workers, the unemployed, or the chronically indebted. 

The Fed’s conviction that low-wage workers must be punished for over-exuberant demand is grotesque. But it is internally coherent. Powell acknowledges that the point of tight money is to reduce business investment and “temper growth.” This economic slowdown will ensure that supposed “wage pressures move back down,” rectifying the “real imbalance in wage negotiating” which Powell now sees as a dangerous consequence of easy money. Contrast this with Petrou, who claims that tighter money will increase investment and employment: “The lower these [rates] go, the less companies spend on investment, the harder it is for lower-skilled workers to find jobs.” She acknowledges that investment is led by demand (“The less the nation spends for overall consumption of goods and services, the less need for businesses to invest in new plants and infrastructure to meet demand”) but believes that somehow tighter money will mean more demand. These tortured constructs reflect a stubborn refusal to accept what Powell freely admits: monetary policy simply cannot reverse hyper-wealth concentration nor revive what Petrou calls “shared growth.” 

It is worth remembering the actual historical contours of “shared growth.” The last time we saw any significant compression of wealth and income inequality was in the postwar era, when federal and state governments poured money into public construction projects and lavishly subsidized the “private” manufacturing sector. Vigorous growth rates meant that wages could rise without threatening the profit share of national income. This is how the limited Keynesianism of the New Deal state was supposed to work. The period after 1965 saw a significant expansion of social and redistributive public spending relative to defense outlays and an upsurge in labor militancy across the private and public sector. When wages kept rising, even as industrial profits came under threat from foreign competition and rising oil prices, industrial employers and financial asset holders alike quickly lost interest in maintaining the Keynesian peace. No longer a respected partner, unionized labor had revealed itself as an enemy of the free-enterprise system and, via “wage-push inflation,” the prime cause of the nation’s economic ills. 

Wage-push inflation could just as well have been dubbed profit-push inflation, since the rise in consumer prices reflected an ongoing struggle between workers and business owners rather than the outright victory of labor unions. Yet the fact that the distribution of income could shift, even momentarily, in favor of workers was enough to dissolve any commitment on the part of business to shared growth. (In 1974, a young Alan Greenspan told a group of social-service bureaucrats that Wall Street stockbrokers were harder hit “percentage wise” by inflation than the poor—an undiplomatic statement that revealed what it really meant to “whip” inflation).¹⁷

Monetary policy and the fiscal state

The long counter-revolution of the last half-century—which has seen central banks relentlessly attack the slightest sign of wage growth while doing all in their power to promote the inflation of asset prices—would not have surprised Michał Kalecki. In a famous 1943 essay, the Polish economist predicted that sustained efforts by government to subsidize public services, welfare, and wages would at some point release workers from the fear of unemployment and therefore generate a powerful backlash coalition of industrialists and rentiers.¹⁸ More than merely diagnosing the dilemmas of full employment, Kalecki’s prescient essay also suggests that the path to revolution might pass through and beyond the fiscal state. When social spending and redistribution is pushed too far, industrialists and wealth holders unite in opposition. But what would it mean to deliberately push Keynesianism beyond these limits—as well as beyond the familial, racial, national, and class-based limits within which the welfare state has historically been confined? Put differently, is it even possible to entertain the prospect of communism today without some sense of how to collectivize the process of money and debt creation? 

Contemporary Marxists have neglected these possibilities. Too often, they invoke a strangely philological understanding of revolution, one attuned to an era before the fiscal state and modern central bank, in which workers merely had to take over the means of production while militants seized the executive powers of the state.¹⁹ But any radical challenge to capitalism today would also need to seize the means of money creation, collective spending, and taxation. When Marxist economists dismiss MMT as a Keynesian half-measure, they are stating the obvious. There is real value in MMT’s claim that fiscal and monetary actions should be judged by their real-world effects rather than their distance from supposed economic laws. But in other respects, it remains committed to the Keynesian project of dialectical mediation, with all its built-in buffers—the distinction between productive and unproductive labor, the confinement of social democracy within national borders, and the fear of excessive wage growth.²⁰ That this is a limited project goes without saying. The whole point of Keynesianism is to moderate the relationship between labor and capital, so that central bank money creation and the state’s power to tax and spend never lead to the full-blown socialization of finance. It is easy to see why Petrou—a social liberal with distinctly unambitious fiscal politics—would shun MMT’s promise to dissolve financial constraints. But for Marxists, time spent rehearsing old critiques of reformism is time away from more urgent tasks. Until we develop our own politics of collective finance, the left will face an unsatisfying choice between celebrating QE or defaulting to a hawkishness that is ultimately hard to distinguish from sound-money nostalgia.²¹

So far, the most creative proposals have come from activist groups like Strike Debt! or the more advocacy-focused New Economics Foundation and Positive Money. Each of these have drawn on the full range of monetary and fiscal alternatives to advocate for a more redistributive economic policy. Although hardly exceptional by the historical standards of Keynesian (or even monetarist) thinking, their demands—for a more expansive social-spending agenda, mass debt forgiveness, or a “Quantitative Easing for the People”—hold far more promise than the return to sound finance promoted by centrists like Petrou as well as the occasional Marxist. 

If skeptics are right about one thing,  it is that such experiments will never be implemented at scale without a fight. Macroeconomic policy is not, and should not, be an exclusively technocratic or parliamentary affair. The fiscal state is just as capable as the factory floor of inciting transformative conflicts. The decade-long upsurge in public-sector militancy is one instance of a labor struggle that directly touches the levers of public finance, and therefore represents a crucial site of fiscal intervention.²² Public-sector unionism is sometimes dismissed as peripheral to the real work of anti-capitalist struggle on the grounds that the fulcrum of capitalist power relations lies in the profit-making private sector. This anachronistic assumption misreads the last century of economic organization, which saw “private sector” surplus-value production massively underwritten by the state, whether through direct subventions, tax expenditures or government contracts, and thereby misses the hidden affinities between public- and private-sector unionism. It also overlooks the genuine fear that public-sector workers are capable of inspiring among political elites, as when Fed chair Arthur Burns described the 1970 postal wildcat strike as “an insurrection against the Government.”²³

The relative importance of public-sector unions in today’s labor movement should not be lamented. As a movement that includes large numbers of women and minority workers, public-sector organizing has the potential to transcend the gender- and race-based trade-offs of earlier worker insurgencies. The sector’s visible dependence on government support—historically seen as a vulnerability—also offers unique opportunities. Public-sector movements are forced to dredge up problems which are usually submerged: the relationship between labor income, asset prices, and government spending; the distributional stakes of taxation and credit creation; the contradictory imperatives of reproducing an increasingly unequal society. That public-sector challenges can become sources of strength is demonstrated by initiatives such as the Bargaining for the Common Good Network, which builds coalitions between striking public-sector workers and their “clients” (students, parents, patients, commuters, etc.) while also coordinating campaigns that join the dots between government budgeting and everyday austerity. To get a sense of how far reaching such campaigns can be, the United Teachers Los Angeles (UTLA) has fought to lift the commercial property-tax limit on school funding; turn school-owned vacant land into affordable housing; and contain the power of the private equity funds which exploit renters (through their real-estate portfolios) as well as teachers (through state tax policies that privilege capital gains at the expense of funding for schools).²⁴ This is a model for unionists public and private. More than that, it represents one way in which the reins of fiscal and monetary power might be seized from below.