In recent years, wage increases have become a pivotal focus for the Federal Reserve, especially as a primary indicator of inflationary pressures. The Fed’s shift towards this practice can be traced back to the Volcker era when labor had a stronger bargaining position and many labor contracts included cost-of-living adjustments. Today’s landscape is dramatically different, and John Ruehl highlights how some of the measures the Fed employs may exaggerate wage growth for lower-income workers, leading to an increase in economic inequality.
This article also touches on the notable role that Paul Volcker played in shaping attitudes toward workers and labor power. While my own experiences at Harvard Business School (1979-1981) did not reflect this perspective, corporate leaders of that time seemed to widely believe that labor was demanding too much, straining businesses. Bill Greider, in his book *Secrets of the Temple*, recounts how Volcker, during his “interest rates to the moon” period, kept a close eye on construction wages to confirm his strategy was working. He believed it was essential for unions to grasp the situation’s seriousness.
By John P. Ruehl, an Australian-American journalist residing in Washington, D.C., and a world affairs correspondent for the Independent Media Institute. Ruehl has contributed to numerous foreign affairs publications, and his book, Budget Superpower: How Russia Challenges the West With an Economy Smaller Than Texas’, was released in December 2022. This article is produced by Economy for All, a project of the Independent Media Institute.
Between 2021 and 2023, inflation surged, leading to significant increases in consumer goods, housing, and asset prices. Although wages also rose, their growth lagged behind other inflationary metrics. When wage inflation finally picked up, the Fed responded with aggressive rate hikes, maintaining its long-standing view that wages serve as a precursor to inflation and require suppression.
On the surface, the average weekly wage data from the past two decades shows a robust picture, often surpassing general inflation. Research from the Center for American Progress indicates that workers, particularly those with lower incomes, enjoyed real gains from the pandemic through late 2024.
However, these statistics can be misleading. Recessionary periods often distort wage data, as lower-paid workers tend to be laid off more frequently than their higher-paid counterparts. Newly hired positions during economic recoveries can artificially inflate wage averages due to higher starting salaries or signing bonuses. Additionally, standard inflation measures like the consumer price index can underestimate living costs for lower-income families, and many wages still remain below pre-pandemic levels. In reality, real hourly wages for the majority of workers have scarcely changed since the 1970s and historically recover sluggishly when they dip.
For years, the Fed has viewed curbing wage inflation as a critical element in stabilizing the economy and curtailing rampant inflation. However, this was not always its primary goal. Established in 1913 to avert banking panics and provide liquidity to distressed banks, the Fed’s role expanded significantly during the Great Depression, leading it to oversee monetary policy and the financial system.
The 1951 Treasury-Federal Reserve Accord restored the Fed’s independence in setting interest rates after government control during World War II, allowing for experimental monetary policies. The Phillips Curve was eventually adopted in 1958, indicating a perceived trade-off between unemployment and inflation. Economists posited that keeping interest rates low would spur businesses to hire more workers, thus increasing wages, which would in turn promote consumer spending.
This method functioned effectively until the 1970s, when high government expenditures, the decline of U.S. manufacturing, and recurring oil crises caused stagflation. The combination of high inflation and unemployment, along with sluggish economic growth, revealed the inadequacies of traditional interest rate policies in managing both inflation and economic expansion.
In 1977, after Congress adopted the Fed’s dual mandate to achieve maximum employment and price stability , the central bank asserted its independence by prioritizing price stability. Under Chairman Paul Volcker, who took the reins in 1979, controlling inflation became the sole focus. Volcker and his colleagues regarded swift wage growth, particularly when fueled by inflation expectations, as a red flag indicating that inflation was becoming ingrained in economic thinking. They argued that if workers anticipated inflation, they would demand higher wages, prompting businesses to increase prices to cover rising costs, triggering a wage-price spiral.
In response, the Fed initiated aggressive rate hikes designed to slow hiring and diminish workers’ bargaining power, maintaining unemployment levels that would support economic activity while curbing rapid wage increases.
Assessing Success and Exploring Alternatives
The Fed’s strategy became conventional wisdom, although its success has been mixed. While it was effective in curbing inflation and reviving economic growth, real wages have stagnated for most workers since that time. Meanwhile, the financial sector expanded significantly, benefiting from higher profit margins and speculation, as the Fed concentrated on managing wage inflation.
However, by the late 1990s, the Fed demonstrated that both wage growth and price stability could coexist. Chairman Alan Greenspan allowed the economy to function at levels higher than some economists had advised, betting that technological advancements would help keep inflation under control. Unemployment dipped to record lows, and lower-income workers benefitted from modest wage increments. In the following decades, inflation remained moderate, yet wages continued to stagnate.
The inflation surge of the 2020s was largely propelled by corporate markups, supply chain disruptions, and energy costs, not wage growth. From the early 1990s to the 2010s, wages did not drive significant inflation. Instead, several asset bubbles (notably the housing bubble of the 2000s) and food and energy price shocks contributed to rising costs.
While economic bubbles typically favor the wealthy, prolonged periods of low inflation do so as well under the current financial system. Elevated interest rates enhance returns on safe assets, like Treasury bonds, benefiting financial institutions and investors, while low inflation reduces the pressure on major corporations to raise wages. The Fed’s commitment to maintaining price stability ensures financial stability, supports government borrowing, and bolsters confidence in the dollar. Consequently, wage growth often lags behind the wealth accumulation at the top, a reality that the Fed seems to accept.
Other nations have adopted different strategies for managing inflation and wage growth. For instance, the Bank of Japan has sought to boost wages since the 2010s to counter decades of stagnant income and low inflation, aiming to invigorate domestic consumption and drive growth. Similarly, China has targeted asset price controls to reduce wealth concentration while promoting wage increases to enhance consumer spending.
Some economic experts advocate that the United States consider similar or alternative measures. Economists Scott Sumner and Christina Romer have promoted nominal GDP targeting, which would redirect the Fed’s focus toward maintaining a consistent growth rate in total economic spending. This would stand in contrast to the current approach, which reacts primarily to price shifts or unemployment, potentially preventing abrupt economic downturns and helping stabilize wages and job markets.
Isabella M. Weber and Merle Schulken and their collaborators emphasize the phenomenon of “seller’s inflation,” whereby dominant firms in specific sectors inflate prices. They propose implementing targeted price controls in certain markets to curb excessive price increases. Economists Bill Mitchell and Warren Mosler suggest a job guarantee model called the Non-Accelerating Inflationary Buffer Employment Ratio (NAIBER), where the government offers jobs at a fixed wage to anyone willing to work. This policy aims to stabilize prices while ensuring full employment.
Additional reforms could include broadening inflation metrics to cover corporate profits, rents, and asset prices, thereby mitigating unchecked wealth accumulation at the top. Lawmakers might also place a greater emphasis on ensuring wage growth keeps pace with productivity rather than simply tracking nominal pay, especially as productivity has surged since 2023.
Achieving sustainable and inclusive wage growth is a formidable challenge. The U.S. no longer benefits from the significant economic expansion and strong labor bargaining power that fostered wage increases for most workers in the post-World War II era. In today’s financial and technology-driven economy, high-skill workers tend to enjoy significant wage gains, while lower-income workers see only sporadic improvements, and the middle class often struggles to catch up.
The Fed’s insistence on controlling inflation has contributed to ongoing imbalances, favoring wealthy households while exacerbating inequality through rising asset values. The prolonged practice of suppressing wage growth in the name of inflation control has proven counterproductive, particularly highlighted by the inflation surge of the 2020s, which was not driven by wage increases. Reevaluating the Fed’s priorities could facilitate an environment in which wage rises for average workers are regarded not as a threat, but rather as a tool to bolster economic stability and alleviate escalating inequality.
