The Federal Reserve has responded to runaway inflation with a spike in interest rates. The real cost of such measures is primarily paid by the working class, who are caught in a double-bind of rising prices of goods and falling wages. As TRNN has covered extensively in the past, the real culprits of rising inflation are multinational corporations and financial institutions, who have opportunistically raised prices, recycled billions of dollars in stock buybacks, and benefited from massive federal bailout packages. Why is the Federal Reserve squeezing workers, and how should the inflation crisis really be solved? Anders Lee interviews CUNY School of Labor and Urban Studies Assistant Professor Samir Sonti on behalf of The Real News to discuss how historical examples like the 1979 Volcker Shock can help us understand how the Federal Reserve will respond to our contemporary situation.
Samir Sonti is an assistant professor at CUNY School of Labor and Urban Studies. He previously served as a special advisor for the presidential campaign of Senator Bernie Sanders.
Post-Production: Brent Tomchik
Anders Lee: Anders Lee here with The Real News Network, talking to you today about the Federal Reserve, which has been getting a lot of attention in business sections throughout American newspapers for its efforts to combat inflation.
But what is sorely missing from the coverage in mainstream media is historical background on what the Fed is, what its functions are, and how we’ve actually been in moments similar to this one in the past. To bring you more about this, we’re talking today with an expert on labor and economics. Without further ado, let’s go to our interview with Samir Sonti.
We are now joined by Samir Sonti, who’s a professor at the CUNY School of Labor and Urban Studies, as well as a writer at Jacobin. Samir, thank you for joining us.
Samir Sonti: Thanks for having me, Anders.
Anders Lee: Yeah. So let’s dive right into it. The Federal Reserve is a very old institution, came about in 1913, and in part was the result of the Populist movement. What was the political and economic situation that led to the Fed’s founding?
Samir Sonti: Well, the late 19th century was a time of pretty significant economic change, and in particular, kind of ironically given what we know the Fed for today, of chronic deflation. And deflation was something that really affected farmers, hit them hard.
Farmers historically have been debtors, and deflation is something that weighs heavily on debtors. If you’ve got a mortgage and you expect to earn a certain amount in a given year and the next year you don’t earn that much because your crops sell for less than you thought, they were going to sell as a result of the deflationary environment, it makes it that much harder to service the mortgage.
And so this crisis of deflation that played out through the latter few decades of the 19th century led farmers to organize around a number of demands, one of which was a reform to the national financial system and the establishment of some kind of public authority to oversee the money supply. At the time, there was no central bank prior to the Federal Reserve. The issuance of money was managed largely by private banks, and in the view of the Populists, it was chronically in short supply.
So a demand, and listeners may be familiar from high school history classes or other things about the free silver calls in the 1890s that the Populists made, but that was just one of a broader set of arguments that they marshaled for a reform of the financial system. And one of them was for some kind of public authority to stabilize prices and to have a more rational management of the money supply.
At the same time, financial interests were concerned about the crises that had marked the late 19th and early 20th century as well. There were a lot of financial crises during that time, and big bankers like J.P. Morgan had to step in and rescue the entire financial system on more than one occasion. And so bankers as well were interested in some kind of public authority. And so the Federal Reserve was established in 1913 as a bit of a compromise between these two constituencies, these two rival constituencies, and the architecture of the Fed is reflective of that compromise.
Anders Lee: Now, the principle of central bank independence often feels sort of synonymous with the Federal Reserve, feels like an iron law to the point where it seems like it’s written into the Constitution, but how far back does that tenet go? And have there been some points throughout history in which it’s been a little more flexible?
Samir Sonti: Yeah. It’s a good question. This tension over the independence of the central bank is one that dates to the origins of the institution. Farmers, the Populists who’d been advocating for who we’ve been talking about had hoped to have greater democratic control over the body. And the bankers who also played a role in it insisted upon being basically in the driver’s seat. And as the statute was written and as the bank initially developed, the bankers largely won out.
It functioned kind of like a private bank that served public ends. That lasted until the Great Depression and the Fed’s failure to prevent some of the banking failures that contributed to the depths of the crisis. And in 1933 and 1935, again, Roosevelt signs a New Deal banking legislation that in part, among a variety of other things, reforms the structure of the Fed, and in a non-statutory way, leads to an agreement effectively between his appointee to leave the Fed. A guy named Marriner Eccles and the Treasury Department, through which Eccles and the Fed effectively agree to subordinate the Fed’s independence to the needs of the Roosevelt administration’s economic program.
This lasts through, in part, to varying degrees during the 1930s and then especially is doubled down on during World War II. And what this means in practice is that the Federal Reserve was supporting the federal government’s debt financing objectives.
To wage the war required a lot of federal spending, a lot of federal deficit spending. And in order to do that in a sustainable way, the federal government needed interest rates that were sustainable over the short and long-term. And the Federal Reserve committed itself to ensuring that treasury bonds would be marketed at rates that the federal government could adequately service over time.
During the wartime emergency, there’s basically a consensus agreement that this is necessary. When the war ends, questions about whether this policy ought to be maintained are surfaced. And the Truman administration insists, and Labor liberals generally insist, that the Federal Reserve ought to commit this program or continue this program.
They see a lot of post-war ambitions around employment policy, around healthcare, around all the things that they hope to achieve through an expansion of the New Deal required a deficit spending program that could be adequately sustained through a reasonable debt service over time, and the Federal Reserve had to play a role in that.
And corporate interests and bankers and so on come to oppose this collaboration between the Federal Reserve and the Treasury Department. And there’s a variety of reasons why. One of the reasons is that there’s a big spurt of inflation right after the war and there are demands, increasing demands that the Fed Act to control it by raising interest rates. But this would mark a break with the wartime policy of maintaining low interest rates. And so this plays out over the course of about five years after the Second World War.
And in 1951, ultimately the bankers prevail in what’s referred to as the Fed-Treasury Accord. And that’s the moment where the Fed, again, basically asserts its independence from the Treasury and thereafter it acts on its own.
But in the decades that followed in the 1950s, 1960s, and into the 1970s, the Fed understood that it was always a political entity and that there was popular concern about interest rates being used aggressively to combat inflation. And the Fed had that in mind and operated with political sensibility. It’s not until a little bit later that we see the Fed really break from this wholesale, and we can perhaps talk about what that looked like under the Volcker years in the late ’70s.
Anders Lee: Well, that’s a great segue into the man, Paul Volcker, whose life really coincides with the modern history of the Federal Reserve. What can you tell us about him as a person, his trajectory, and his current influence?
Samir Sonti: Yeah, yeah. You’re right, Paul Volcker’s life really does map onto a big good part of the history of the Federal Reserve. He just died a few years ago, and he came of age in the Depression and was a student and was an econ major at Princeton at a time when Princeton famously, as he notes in his memoirs, had no Keynesians. He didn’t learn anything about Keynesian economics as an undergrad. But he was a very bright young person and wrote a senior honors thesis at Princeton about monetary policy that ended up being quite sophisticated in the way that certain financial interests would like to see monetary policy conducted.
In any case, he bounces back and forth between the government and the banking industry over the course of a few decades and ends up in pretty high places in the Treasury Department, and is an advocate by the 1970s of a really draconian Federal Reserve response to the inflationary crisis of the 1970s.
So just to maybe fast forward a little bit, in the 1970s, we see a high level of inflation, much higher than we’re seeing right now, as a result of a variety of things. And they’re still debating what the causes of this were. But persistent inflation in the double digits through the 1970s. And Volcker, who ends up during the ’70s being the president of the New York branch of the Federal Reserve, is an advocate of a very strong and aggressive federal monetary policy response to it, which is widely understood. I mean, everyone understands what this means. It means a recession, a deep recession. It means workers pay a significant toll if we’re going to raise interest rates through the roof to combat this.
And as a result, the political, and this goes back to the politics surrounding the Fed, the political center of gravity wasn’t quite at a place where someone like Volcker would be running the show. But now get to the late 1970s. In 1979, Jimmy Carter is in the third year of his presidency. He’s looking at an election the next year, inflation is just running away. There’s another oil crisis resulting from the crisis in Iran. And Carter appoints Volcker to lead the Fed. And there’s still probably more history to be written about the exact thought process that Carter and Carter’s advisors had as to why they appointed him.
One clear answer is that they were very concerned about the integrity of the dollar at that moment and felt the need to send a signal to international financial markets that they were very serious about maintaining the integrity of the dollar. And Volcker, as a fairly ardent advocate of harsh or sound money policies, was that kind of signal.
So they appoint Volcker in 1979, and he proceeds to implement the most draconian monetary policy in US history: contraction of the money supply, which results in interest rates soaring to close to 20%. And this leads to a recession in late 1979, 1980. That continues for the next couple years, the worst recession that we had since the Great Depression.
And it’s one that, among other things, ushers in Reagan, but it’s also one from which working people in this country really haven’t recovered from, the wave of plant closures across the industrial Midwest. A weakening of the industrial union movement that rang and then capitalized on over the years to come. And really the beginnings of the breakdown of that New Deal labor industrial coalition.
And I should say Volcker was quite clear that he understood this was going to be the effect of it, and he wanted it to be the effect of his action. Volcker, infamously, I suppose, carried around a note card with upcoming union negotiations. He cheered Reagan’s attack on the aircraft controller strike. He very much believed that in order for inflation to get under control, the working class, the organized working class had to be taken down a notch. And he saw monetary policy as one tool in a broader war on the working class.
And Volcker was a Democrat. He wasn’t a Republican, and he remains a Democrat for the rest of his life and is an influential advisor to Obama later on. And I think this speaks to where things were at that moment, that a Democrat like Carter could appoint a Democrat like Volcker to wage this war on workers. And it suggests this seriousness of the politics of inflation at certain points in US history.
Anders Lee: Yeah. And a lot of critics from the left have excoriated people like Volcker or Powell today as really being warriors on behalf of the ruling class. I’m curious, to what extent do they see that as their role? Do they just view this as all just numbers, objective, or is there an ulterior motive? Do they have a sense of class consciousness in what they do?
Samir Sonti: Yeah. It’s a good question. I suspect it varies over time. In an era like the ’70s when the US organized working class is much stronger and could be arguably seen as exerting an inflationary impact, one might think that Volcker clearly had a degree of consciousness around this. He was very intentional and explicit about the need for unions to dial it down.
Powell, today, it’s just such a different moment given the degree of weakness of the organized working class, and yet Powell’s principle concern is not so much where inflation is today – And notably it’s just come down. We heard a report that it came down – But where it’s expected to be a few months, a year from now, and the expectation of inflation, in Powell’s view and the view of most central bankers and orthodox economists, is indicated by wage pressures.
So at the end of the day, the Federal Reserve, I’m not sure that it’s worth putting in conspiratorial terms, but the Federal Reserve does operate on something like a class analysis about the balance of power in society and the extent to which wages are potentially going to be drivers of price pressure. And they’re okay with wages rising as long as they’re not threatening to push up prices.
I think Powell probably does believe earnestly, or does hope earnestly, that he can achieve what he calls a soft landing, which is to raise interest rates to combat inflation without generating too much unemployment. I don’t think that he’s eager to punish American workers in the same way perhaps that Volcker was at that moment, but he’ll do it if he has to. And he does believe that wage growth has to slow, and if the only way for wage growth to slow is through higher unemployment, then that’s a price he’s willing to pay.
Anders Lee: One thing Volcker had to contend with in the late ’70s was the Humphrey-Hawkins Act, which originally tasked the Fed with pursuing full employment. I believe it was amended to just task it with employment maximization. How did he grapple with that order?
Samir Sonti: Yeah. So this notion of a dual mandate, which comes out to Humphry-Hawkins of maximum employment and stable prices, there’s actually a third mandate as well there, which is moderate long-term interest rates, that the Federal Reserve actually has three objectives and that third one gets forgotten, but it’s important in terms of thinking about investment over time, and it suggests the extent to which Congress has, in the past, seen the Fed as an institution that ought to be supporting the development of productive capacity in the United States. Which is something that I think the Biden administration could be pointing to a little bit more forcefully right now.
But to your point about maximum employment, Volcker, I mean, he simply ignored it. I think what he would’ve said at the time is, in order to achieve maximum employment, inflation’s got to come down. And this is a line you hear today as well from people like Larry Summers, that allowing inflation to run is only going to result in some kind of crash eventually. And beginning the work of improving employment standards is conditional upon getting inflation down to begin with. So it’s almost like we have to take the medicine before we can start to pursue maximum employment.
Maybe that’s perhaps a formal argument that one would make to justify the actions. But the long and the short of it is that Volcker effectively dismissed that responsibility and saw the issue of the moment, which in the ’70s was both unemployment and inflation, the crisis of stagflation, which is what the term of the era is one of sluggish economic growth, relatively high rate of unemployment, and inflation.
And this is what put the Fed in such a difficult position because when you got both higher than you’d like unemployment and higher than you’d like inflation, monetary policy requires a pretty significant choice between either worsening the unemployment through high interest rates or tolerating the high inflation through lower interest rates. And Volcker made that choice quite clearly by pursuing a high interest rate strategy of controlling inflation. And he knew what the consequences were going to be and Humphrey-Hawkins wasn’t going to stop him.
Anders Lee: And how much to do with today’s current anti-inflationary measures that Powell is taking, does Volcker have to do with it? Did he set a precedent that Powell is now following?
Samir Sonti: It’s a great question. Initially, in Powell’s tenure, and certainly in the early days of the pandemic and even once this inflation picked up I might have answered otherwise because Powell was rather cautious in how he responded to the inflationary pressure through 2021. And he argued that it was transitory in the same language that Biden did and suggested a somewhat more progressive outlook on it even though he was a Republican, he was appointed by Trump.
But it’s clear since then that he hasn’t been able to resist the temptation or the ideology and the pressure to react. I would say ultimately what we’re seeing is that Powell today, and really all central bankers today, are operating within a paradigm that was created by Paul Volcker. The experience of the 1970s and the legacy of the 1970s continues to haunt central bankers. The possibility that inflation can become unanchored or inflationary expectations, as they would say, could become, in their terms, unanchored and run away, is something they seem to really obsess about.
And for about a decade after 2008, they didn’t have to, because inflation was actually too low and they were concerned about it being too low. But now they seem to have reverted right back to where they were prior to 2008 with this presumption that the first order of business, the number one priority for the central bank is to prevent inflationary expectations from rising. And that requires taking forceful action to control it.
I suspect that they don’t even believe that their actions right now are going to get at some of the real drivers of inflation, energy prices and this most recent inflation report, housing prices, rent. They know that higher interest rates aren’t going to affect what’s going on in Ukraine and aren’t going to affect global energy markets, but they feel the imperative of being seen to have taken action for the sake of the market’s expectations of inflation going forward.
And so Paul Volcker made the world that they all exist in, and that hasn’t changed. And as long as that doesn’t change, it’s hard to imagine a way towards a more progressive inflationary policy. And I think we only get there through politics outside of the Federal Reserve.
Anders Lee: Well, now I’m wondering how likely do you think it is that Powell’s current Fed policies will induce the recession of the kind we saw in the late ’70s early ’80s, or perhaps one that we saw in 2008?
Samir Sonti: That’s a good question. If I knew the answer I could make a lot of money betting on it. But it seems that the markets think that there’s going to be some kind of recession. The severity of that is hard to say, but it does seem likely that there will be some kind of slow down.
Now, who knows, given how much… There’s been a lot of stimulus pumped in as well and is the economy in a better position to weather these interest rates than we think? It’s possible, I think it’s anyone’s guess. I’m better at predicting the past in the future, I would say whether or not it’s likely to happen is one thing. What is certain is that they’re willing to make it happen if it’s required. And I think that’s perhaps the more important takeaway from this.
Inflation is something that we’ve obviously experienced for the last couple years. It seems at least reasonable to expect that there may be a greater degree of inflation in the air over the next years to come as opposed to the past. I think the pandemic showed the extent to which supply shocks can create durable inflation, and the climate crisis is one thing that is, if nothing else, going to create supply shocks.
And so the possibility of living with a greater degree of inflation in the years to come is real. And if the Federal Reserve is willing to induce a recession to deal with it, that’s something that anyone committed to a working class politics has to contend with.
Anders Lee: Well, this brings me to somewhat of an ongoing debate between a couple contemporaries of yours, Doug Henwood at Jacobin and Adam Tooze, who you recently interviewed are at loggerheads, respectful loggerheads, about whether or not inflation is an elite concern. Do you agree with that assessment or is it something that the left needs to address head on?
Samir Sonti: Yeah. I mean, I think it is more than an elite concern. I won’t weigh in exactly on the terms of their debate because I think they laid it out better than I could, each of their positions. But what I would say is I do think this is something that left and the labor movement and all of us who care about a better world ought to be concerned about.
Inflation affects people’s lives. It takes a toll on people, whether or not its political impact is what one might predict is a different question. I think the election results ought to be processed in a certain way. I mean, who knows how much inflation actually figured into the election outcome. But the bottom line is that it does affect working class people and we’ve seen real wage growth slow over the last year even though nominal wages, your paycheck, people’s paychecks are rising, but real wages are not rising as a result of the extent to which prices are going up. So there’s that.
There’s also the fact that inflation control policies as it exists hurts working people. That’s a serious issue. If left to its own devices, if that is going to respond to inflation with a certain kind of monetary policy that is likely to have a disproportionate impact on working people through its effects on employment. And so that’s a concern of ours.
And if, at an even broader level, if we want to see real structural change, if we want to see something that can sustain beyond the Inflation Reduction Act. Sustained investment in green infrastructure, something like a Green New Deal, if we want to see healthcare for all and more public housing and public investment broadly, and full employment sustained, we got to understand that all of this comes with the risk of inflation that may be, again, left to its own devices, the Fed will respond to with a monetary hammer.
And so inflation’s a concern because we have to figure out if we’re going to have any shot at building a better world. We got to figure out how to control it, on terms that are egalitarian and on terms that don’t hurt working people. And ultimately, there’s no way of answering this question without looking at class power and who pays and who benefits.
Anders Lee: Well, as you mentioned earlier, change is not going to come from inside the Federal Reserve. It has to come from a mass movement. But I’m wondering if you think there is a role for central banking under socialism, and what are some demands, perhaps, that a movement could place on the Federal Reserve to democratize it and make it perhaps more egalitarian?
Samir Sonti: Yeah. Well, I mean think the example to look to is probably, again, the New Deal in the World War II era when the Federal Reserve played a role in supporting the federal government’s spending objectives. I think here, then now you kind of start, there’s a school of thought, and this is part of the debate that you referred to earlier between Doug Henwood and Adam Tooze around modern monetary theory and the role of monetary policy and financing expansionary fiscal policy to ensure things that we have things like full employment and so on.
I think there’s a strong degree to which that could be the case, that could play a more active role in a central bank under a social democratic or socialist society, could play a more active role in ensuring that the government’s able to undertake deficits to spend, to undertake long-term investments like what we’re going to need to meet this climate crisis.
But at the same time, there’s no path around the underlying class politics of inflation, which are that inflation is, to put it in somewhat abstract terms, an expression of competing claims on a given income. The share that workers get and the share the capitalists get, and fights over shares of income are often translated into inflationary terms. And at the end of the day, we can’t resolve this issue without confronting that fact, without taxing corporations, without taxing the rich more, without taxing everyone more, probably, to pay for the things that we need.
And so the Fed, I think, surely has a role to play in a more progressive future, but monetary policy is not going to be a panacea. It’s one tool, but a much more aggressive class politics around taxation and control of profits and control of investment and control of capitalism as we know it is also going to be required.
Anders Lee: Well, Samir Sonti, I think that’s a great note to end on. You can read several of his pieces in Jacobin, including “Red the Fed”. Thank you so much for joining us.
Samir Sonti: Thanks so much for having me, Anders.
Anders Lee: Yep. I’m Anders Lee with The Real News.
Hi everyone. Anders Lee here for The Real News Network. I have been watching The Real News since I was 16 years old when it was just a little voice in the wilderness. Times have changed, but our work here is more important than ever.
The Real News is an independent, viewer supported, nonprofit media network. So please, please take a moment and click the link in the show notes or head to therealnews.com/support and become a monthly sustainer of our work.