Hiking Interest Rates Protects Financial Assets of the 1% at Workers’ Expense

After two decades of low and stable inflation rates for more than 20 years, high inflation has returned. Inflation has been rising at a rate of 2 percent for decades, but central banks are now faced with the opposite task. The Federal Reserve announced in June its largest interest rate increase since 1994.

Will a hike in interest rates fix the real reason behind today’s inflation, which is now a global problem? What does the Fed rate hike for the average worker and the poor mean? What other ways can you combat the rising inflation? Why do capitalist governments care more about inflation than they worry about unemployment or inequality. Progressive economist Gerald Epstein sheds light on these and other questions about today’s inflationary economy. Epstein is professor of economics and founding co-director of the Political Economy Research Institute at the University of Massachusetts-Amherst and a leading authority in the areas of central banking and international finance. He is the author or many books, including most recently, The Political Economy of Central Banking What’s Wrong with Modern Money Theory? A Policy Critique.

C.J. Polychroniou, C.J. This is the highest interest rate hike in decades, but it wouldn’t be surprising if the Fed took even more aggressive actions in the months ahead as part of its war against inflation. How big of an impact will higher interest rates have upon inflation?

Gerald EpsteinIt depends partly on how high and how long the interest rates are raised. In general, moderate increases in interest rates — say, 1 or 2 or even 3 percentage point increases — cause only small reductions in the inflation rate, which is defined as the percentage rate of increase of the price of a market basket (collection) of goods and services over a period of time. There are many reasons why this is so. One reason is that interest rates have risen, as Wright Patman, a populist congressman from Texas in 1950s, repeatedly stated. Increasing prices! Companies that borrow money for their operations will have to pay interest costs. Businesses that rely heavily upon credit are likely to pass on higher interest costs to customers.

Concerning the price Reduce impacts of interest rate increases — these occur only indirectly. The main channels of interest rate increases are through raising the cost to borrow by families for their homes (mortgages), or by increasing the cost to purchase credit cards. Companies that plan on building new factories or purchasing capital equipment can also raise the cost of borrowing. These reduce the demand for goods and services — houses, appliances, cars, new factories and capital equipment — and the workers that produce them.

It is here that possible price reductions and rates of inflation can be made. Workers and companies are reluctantly willing to lower their prices, or reduce the rate at which they pay for wages and other expenses. So, what happens next depends on the power that workers and capitalists have to keep their wages and prices up — to wait out the reduced demand for their products and services until demand goes back up.

Firms have a lot more flexibility to deal with cutbacks without drastically lowering their prices. This is especially true for firms that have a lot price power, such monopolies and large market share like mega-corporations. Workers are less affected. As the demand for products decreases and the unemployment rises, wages tend to either fall or stop increasing. Perhaps housing prices begin or slow down. The inflationary pressures could ease over time.

However, this can take a significant amount of time. EstimatesRay Fair, a well known Yale economist, indicated that a 1-percentage-point increase in short term interest rates would reduce the inflation rate to one-half percentage point. However, this only happens after 15 months. So, as estimated by macroeconomist Servaas Storm, it would take a 4-percentage point increase in the Fed’s interest rate to reduce the inflation rate by only 2.5 percentage points — say from 6 percent to 3.5 percent — far above the Fed’s target of 2 percent. The price for this modest drop would be an increase of 1.5 percentage points in the unemployment rate and a significant fall in GDP.

These weak anti-inflation effects are likely to underestimate the impact of interest rates increases on current inflation. Because so much of this inflation is caused by production disruptions outside the U.S., interest rate increases will have at best weak effects.

The libertarian economist Milton Friedman famously said that inflation is caused by “too much money chasing too few goods.” He assumed that the culprit here was “too much money” — typically printed by the Central Bank (the Federal Reserve in the U.S. case).

But, historically, most really serious inflations are caused by “too few goods,” not too much money: that is, serious disruptions in the supply of goods. These are usually associated with political instability, droughts, and wars. This is also true for current inflation.

Most of the drivers of our current inflation come from disruption in the supply of key commodities such as oil, gas and food, and other key parts of the “supply-chain” such as microchips for automobiles. Some of these disruptions remain due to the COVID pandemic as well as the subsequent shutdowns. Now, add on the sharp rises fuel and food costs resulting from Russia’s invasion of Ukraine and the Russian blockage Ukraine’s food exports from the rest of the world.

According to Servaas StormThe increased inflation we are experiencing is due to increased import prices to the U.S.

In addition to the external sources of production and distribution (i.e., “supply-side”) disruptions, the U.S. has domestic disruptions as well. Some of the most well-known include a shortage of truckers, inefficient ports, and a decline of the labor force relative pre-COVID trends. This last one is important, but it is not well understood. It could include COVID-related health issues, poor work conditions and pay, more family obligations, or other factors.

The fact is that interest rates increases will not solve these problems. In fact, they might make it harder for families to access the care they need. they could return to work.

In short, even when we are experiencing “plain vanilla” inflation due to too much demand (“demand-pull” inflation), interest rates must be raised significantly and for a long period of time to reduce it, at considerable cost in lower economic growth and higher unemployment. When the main causes of inflation include supply side factors, and especially those that occur abroad, the effectiveness of interest rate increases to combat inflation is much, much lower. To achieve the same gains in terms lower inflation, workers must suffer more.

Who wins and who loses from the Fed’s interest rate hike?

The current inflation, caused by significant disruptions to the supply of key commodities such as gasoline, food, and other goods, has a severe impact on the poor and working-class in the U.S. These price increases are like a big hike in sales taxes, which is a “regressive” tax: That is, it most negatively impacts those groups who spend a high percentage of their incomes on these goods. These goods are essential and account for a large percentage of these people’s purchases. These goods are more expensive for very wealthy people than those of working class, but it is a smaller percentage of their incomes. These necessities are essential for families and the poor. It would be a great help to lower their costs.

As we’ve seen, interest rates increases will not accomplish this, at least not without affecting these same groups. An increase in interest rates will lead to increased unemployment, decreased economic growth, and higher mortgage interest rates. This makes housing more expensive for these people.

The interest rate increase will benefit two groups: those with substantial financial wealth and financial institutions that lend money. These institutions will be able to charge more interest and their financial assets, which will retain more of its value if inflation falls.

Many people will wonder if higher interest rates are for wealthy investors after they have seen the stock markets fall in recent times. While there will be a decrease of the value of financial assets such stocks, it is also true that the rates of return on new income will be higher. Moreover, to the extent that, in the longer run, the higher interest rates limit inflation, it will reduce the possible erosion of the real value of the wealthy’s considerable wealth.

Another group that can benefit from high interest rates that will increase unemployment rate is the capitalists who hire workers.

The Fed and capitalist countries are more concerned with inflation than they are about unemployment, poverty, or economic inequality. Why is this so?

The simple answer is that capitalists, of all stripes, are generally harmed by substantial inflation, and they tend not to benefit from unemployment and poverty. All of these factors decrease the power of workers and increase power and wealth for capitalists. These policies are reflected by the preferences of capitalist segments and tend to be influenced (if not controlled) by the Fed and capitalist governments. This can be viewed in two ways. One is to consider capitalists as being divided into financial capitalists (bankers and rentiers, financial operators) and the other as non-financial capitalists. (auto producers, internet agrobusiness etc.). This is not a good way to think of it because there is often a lot overlap among these groups.

To continue: The financial capitalists, and rentiers, are particularly concerned about inflation because unexpected increases of inflation can reduce the purchasing power their financial assets. Non-financial capitalists are more concerned about workers having too much power. They can use this power to increase their pay, improve working conditions, and have greater control over the firm’s decisions. Karl Marx noted the fact that capitalists adore the ability to “discipline” workers so they can’t exercise their power, and the main mechanism that capitalism has to do this is to throw workers out of work — that is, create unemployment. Marx called this the “Reserve Army” of the unemployed. In Das Kapital,Marx observed that capitalism requires periodic replenishment of the reserves army of the unemployed in order to keep workers in line.

The non-financial and financial capitalists typically are united with respect to monetary policy when unemployment is low and inflation is high: the Fed should raise interest rates to throw workers out of work, prevent them from raising wages, and thereby put downward pressure of prices and inflation in order to protect the real value of their wealth and increase capitalists’ profits.

The question above asked who has been able to benefit from higher interest rates in this current environment. The bankers and non-financial capitalists.

What does today’s inflation and Fed policy teach us about capitalism?

Bankers, banker-friendly economists like Larry Summers, his associates, as well as pundits in media are all pushing the Fed to take drastic measures to reduce inflation. Even though these measures will severely injure the people they purportedly aim to help by putting them out of work, Summers, among others, has been claiming that the Fed must raise interest rates dramatically in order to stem a “wage-price spiral,” blaming workers’ wage increases for sustaining the higher inflation rates. This is false since workers’ average wage increases have only been a small fraction of the increases in prices.

This implies that workers in America, who have received very little or no pay increase in 40 years, can’t be allowed to get any pay rise now, despite the fact their incomes and wealth have increased more than 10 times in the past decade. This is especially harmful to African Americans and other peoples of color, who are only able to make ends meet during periods of low unemployment. These calls are being made in the context that economists at the Roosevelt Institute, Economic Policy Institute,And elsewhere have identified as a significant “profit push” component to our current inflation: Mega companies with substantial pricing power are using the supply chain shocks and Russian war in Ukraine as excuses to flex their pricing muscles and raise their profit margins to 70-year highs.

This means that American capitalism is incapable of delivering higher standard of living for the majority of its citizens. Critics often refer U.S. capitalism as “neoliberal capitalism.” I think of it as “rapacious capitalism.”

This statement is not applicable to all capitalist countries, but it does apply to U.S. capitalism. Capitalist countries, such as the Nordic countries (Norway, Sweden, Denmark) where workers, unions and social democratic parties have had significant power in the aftermath of the Second World War, have, for a number of decades, been able to “tame capitalism” to the extent that income distribution was more equal and real gains have been made by the working class and poor. Although these gains have been reduced to a certain extent in recent times, they remain.

But this drive to have the Federal Reserve raise interest rates to bring down this inflation no matter what the cost reflects the “rapacious capitalist chorus” which has far too many powerful members.

What other methods can be used to combat inflation?

There are many other tools that can be used to combat this mostly supply-driven, profit-driven inflation. However, they require coordination between the Federal Reserve overall and the government. There is no denying that something must change. This supply-driven disruption is having significant negative impacts on the standards of living of millions of people — in the United States and around the world — because it is raising the cost of a number of key goods that people need to live and thrive: fuel, food, housing, transportation.

What then? I already know what the Fed should do. Notbe doing: raising interest rates to an all-time high. To understand what the Federal Reserve can help, you must identify what the policy’s goal should be. Federal Reserve Policy should have three goals.

  1. To ensure the standard of living for the majority of the population and those most at risk, not just the bankers or non-financial capitalists.
  2. To alleviate supply-side issues where possible and not to make them worse.
  3. To facilitate, wherever possible, the transition to a nonfossil fuel-based economy and not make it more difficult or slower. This will help to address the longer-term cause of inflation, namely climate changes.

The Fed cannot operate independently to achieve these goals. As it did in the great financial crisis, and more recently, in the wake COVID, the Fed must work with a broad government plan to address the cost-of-living problem. The Fed came up with a variety of innovative and creative solutions in those cases. bail out the banks and financial markets.

The Fed should make the same effort and show creativity this time to control inflation, without imposing costs on workers or limiting the future possibility of preventing catastrophic climate change.

The Biden administration tried to lower the cost for fossil fuels. A better approach is suggested by Jim BoyceBob Pollin, and others, are proposing to tax oil profits, and return the receipts back to people. This will keep the incentive to switch to green energy from fossil fuels, while also helping the poor and workers with the drop in their standard of living.

The government should tax the excessive profits of corporations and use the returns for food subsidies and other necessities for the working class and the poor.

Isabella WeberAnd James GalbraithSome have suggested price controls on key commodities to stop the inflationary dynamics.

Financial speculation has been one of the main factors in these dynamics. This has caused prices to rise faster and higher than if there was simply supply and demande. The Federal Reserve and other financial regulators should enforce rules to limit speculation that is driving some of this commodity inflation.

As I mentioned, the Fed provided billions of dollars in bailout funds for financial markets and banks in 2008-2009 and again in spring and summer 2020. The Fed should create special credit facilities that provide financing for green energy expansion, credit to expand daycare and community health facilities, as well as new initiatives for environmentally-friendly farming to provide food. These would all help to reduce bottlenecks. The Fed could do this by providing lines of credit, insurance and other facilities from community banks, special agricultural loan funds, affordable housing institutions and other similar financial institutions that have experience and a track record in funding these key goods… all of which are implicated in the current inflation.

This means that the Fed should not focus on reducing demand, but on increasing supply.