OK, WTF Is Going on With Inflation, Interest Rates, the Fed, Jerome Powell, Gas Prices, the Economy, Your Job, Rent, Etc.

Everyone is screaming, crying, and throwing up over inflation, the economy, gas prices, interest rates, housing prices, food prices, the supply chain, the stock market, a bear market, and things of this nature. If you work at a tech company, you’ve probably received some sort of email from your CEO about uncertain times ahead, or perhaps you or someone you know was just laid off. If you have any cryptocurrency, you may have noticed that, uhh, things are bad. If you’re lucky enough to have a 401(k) or stocks of any sort, you may want to avoid checking your balance. If you have a car and you’ve filled it up with gas lately, you probably wanted to cry. 

There are many, many articles and explainers for people who read the Wall Street Journal or Bloomberg, all of which are talking about interest rates and the Fed and things like this. All of these articles are probably useful if you already believe you know how The Economy works, or are old and lucky enough to have had money or a job during previous crises in 2008 or 2000 or way back in the early 1980s; these articles are decidedly less useful if you’re new to the workforce or haven’t been paying attention to exceedingly boring press conferences largely given by old men wearing dark blue suits in dark blue rooms at podiums in Washington, D.C. I am not an economist and I am not an expert, but I do want to know what’s happening to the money we all need in order to live, so I spoke to some experts and read some articles and listened to some very long podcasts and believe I can at least posit a grand theory of everything that may help get you started on your exciting journey to learn about, uhh, macroeconomics.

WHAT JUST HAPPENED

I am writing this article because on Wednesday, U.S. Federal Reserve Chairman Jerome Powell announced that “the Fed” is increasing the "federal funds rate" by .75 percent, the largest increase since 1994, and revised how high this rate will eventually go by the end of the year. The "federal funds rate" is essentially the interest rate at which banks and institutions can borrow money, and affect the interest rates businesses and people will pay when they borrow money. This rate was 0 percent during much of the pandemic (free money!) and now has a target rate between 1.25 and 1.5 percent. 

This increase is designed to slow inflation by making it more expensive to borrow money, which will have knock-on ramifications for everyone even if you are not buying a house or a car, don’t have or want stocks, or own or aspire to own a company. What it means in concrete terms is that lots of people are probably going to lose their jobs soon as part of an explicit attempt to get people to buy fewer things, bring down wages, and basically slow “demand” in the economy so that the prices of things become lower or, at the very least, do not increase as fast as they’ve been increasing.

Last month, Powell said “wages are moving up at levels that would not over time be consistent with 2 percent inflation over time. And of course, everyone loves to see wages go up and it’s a great thing, but you want them to go up at a sustainable level because these wages are to some extent being eaten up by inflation.” He also described trying to create a “path” to “get wages down and then get inflation down without having to slow the economy and have a recession and have unemployment rise materially.”

What this means in very real terms, according to Zach D. Carter, a writer in residence at Hewlett Foundation's Reimagining Capitalism initiative, is that people are going to lose their jobs. 

“Throughout the macroeconomic profession and monetary policy sphere, people like to elide this point that raising interest rates will somehow magically bring prices down,” Carter told Motherboard. “They don’t talk about the mechanisms by which it actually lowers prices. The way it lowers prices is by reducing household income, specifically by reducing the income households get from labor.”

The U.S. has had very low interest rates for a very long time, which has made it easy and inexpensive for companies to borrow money, which has allowed them to aggressively hire and grow (and also encouraged companies and investors to borrow money and recklessly speculate with it). This, along with COVID and what employers called a “labor shortage,” recently increased wages and led to record low unemployment, which workers got to enjoy for, like, three months before inflation started eating into what little gains they made; now rising interest rates will probably hurt a lot of people even more. Companies, meanwhile, have argued that they need to raise prices because they've had to pay workers more, all the while making record profits.

“The way you reduce wages is basically through layoffs and pay cuts. When you raise interest rates, you are tightening financial conditions. You are making it harder for businesses to get loans to finance ordinary operations. When it becomes more expensive to borrow money, businesses cut costs in other places, notably labor,” Carter said. When people are laid off, people make less money, so they buy fewer things, so prices go down. There are more people searching for jobs, the “labor crisis” eases, what little power workers recently gained shifts back to companies, and people have to accept jobs for less money than they have had to in recent years. More or less. 

This is already happening, of course, with layoffs hitting a variety of sectors and startup CEOs talking about how they need to do layoffs to weather whatever is coming.

HOW WE GOT HERE, OR: A BRIEF HISTORY OF THE LAST 30 MONTHS

In March 2020, everyone (mostly) accepted that a deadly novel coronavirus was spreading all over world, causing a very bad pandemic that has killed millions of people and continues to this day. Businesses shut down, people were asked to stay home, and the stock market crashed. Congress pumped trillions of dollars into the economy to expand unemployment benefits, and gave everyone thousands of dollars in the form of stimulus checks. 

Interest rates, which are broadly set by the U.S. Federal Reserve and then trickle down to banks, mortgage lenders, venture capitalists and so on (this is a complicated process involving the Fed buying and selling things until interest rates are where it wants them) were set at historic lows, making it exceedingly cheap to borrow money both for corporations and for regular people. People stuck at home in their shitty apartments began to hate them and looked to either buy new houses or remodel the ones they already had. Demand and supply-induced shortages of lumber and building supplies caused prices of both to skyrocket, and happened as lumber mills shut down and it became hard to ship wood because of COVID. Low interest rates let people buy “more house” or let them get into the housing market for the first time because they didn't have to fork over as much to the bank for interest. House prices skyrocketed because we have a huge shortage of housing stock in the U.S. due to a bunch of bullshit that’s better explained in another article. This basic process played out in all sorts of areas and is why if you wanted to buy something like a guitar or a bicycle over the last while you may well have found yourself out of luck.

All sorts of other things happened as well, as you surely recall: Payments on student loan debt were deferred; payments on mortgages were deferred; eviction moratoriums were enacted; and America generally, if temporarily, had a safety net more worthy of ostensibly the richest country in the world, with stimulus checks helping. All of this money had fewer places to go than it had, with restaurants/music venues/weddings in many parts of the country closed or canceled for months and travel plans off the table, leading to a record levels of savings for many Americans. At some point, people stuck at home begin buying more things with this money or their savings. COVID outbreaks and lockdowns all over the world, as well as supply chain issues, made some products, like microprocessors, harder to find and more expensive. 

Early in the pandemic, we began to label certain workers as “essential.” Some of them (rightfully) got hazard pay. In the short term, people were laid off from their jobs and realized that their jobs sucked anyway, and that they weren’t getting paid enough to deal with this shit. Employers began to realize they could no longer get away with paying people $7.50 an hour to do awful jobs where they were exposed to a deadly pandemic and were treated like garbage. Employers also began to complain about a “labor shortage,” by which they meant (and mean) they can’t hire people at low wages to work for their companies. At some point, companies realized that they could hire people, they just needed to pay them more. Average wages increased for the first time in a very long time (though they are still far behind the increase in corporate profits); people had more money. A bunch of people threw money at random cryptocurrencies and NFTs, as well as meme stocks like GameStop and AMC. 

Used car prices increased because new cars became difficult to find and because people stopped vacationing internationally; rich people in cities stopped taking public transit and bought cars instead. Reduced supplies of cars led to “inflation” in the used car market, meaning cars began to cost more. Some people began grumbling about inflation and said that inflation is bad, though this was more gestural than anything, since most people do not remember inflation because the last time really bad inflation happened in the U.S. was in the early 1980s. Smart people and economists claimed that inflation was most likely “transitory,” meaning it would last for a few months and only in specific sectors, and then would go away. 

Then Russia surrounded and invaded Ukraine. Many countries sanctioned Russia, a huge global provider of oil and natural gas. Energy prices increased all over the world as a result. War in Ukraine led to general uncertainty, as well as shortages of wheat, a large amount of which is grown in Ukraine and parts of Russia and which is a key ingredient in many foods (obviously). Giant oil companies jacked up the prices of oil even though they continued to make record profits. Food prices, which started rising in the pandemic, began rising even more; other stuff began to cost more because it costs more to ship it because gas is more expensive. People finally wanted to travel again, but plane tickets, hotels, and rental cars cost exorbitant prices. Rents went up to record levels because housing stock remained low. People kept buying a lot of stuff even though they had begun to worry about inflation, the thinking being that it is better to buy stuff now before inflation gets even worse and the dollar goes even less far than it does now. This makes inflation worse, not better, with the same ordinary working people who were just recently starting to enjoy moderately decent wages and being able to put a little money aside being hit the worst

To recap: People had a lot more money and little to spend it on besides physical objects and/or houses. At the same time, physical objects were getting harder to obtain for a variety of reasons, which made them more expensive, which made money worth less than it was worth before. 

THE FED, INTEREST RATES, INFLATION, BLAH BLAH. 

Very slowly at first—initially, the noticing seemed to come largely in the form of conservatives and right-wingers complaining about the prices of burritos and such in Joe Biden’s America, with liberals claiming that rising prices were not in fact rising—but then very quickly, people begin to panic about inflation, which means they are panicking about prices going up. The Federal Reserve, chaired by Powell, is responsible for keeping the economy stable, conducting monetary policy, maintaining maximum employment, keeping inflation at reasonable levels, etc. Powell is trying to avoid a "wage price spiral," where wages go up, so people buy more things, prices go up because of increased demand because people are buying more things, wages go up to match inflation, prices go up, and so-on forever until we all die.  

Thus, as Carter said, Powell is increasing interest rates to try to slow inflation, but it is not really clear that this is going to work, in part because a lot of the inflation we're seeing seems to be being driven by increased oil and energy prices, increased food prices, and other knock-on effects associated with the war in Ukraine, sanctions, and the pandemic. This is not something the Fed—or anyone—can really control other than using the one thing it can really do, which is set target interest rates, to make life so expensive that people don’t want to buy or do anything, which, after much suffering, will theoretically bring down the price of energy. (This is a bit like using a novelty-sized cartoon hammer to hit a nail.)

"It looks like this is a story about energy, and particularly Ukraine," Carter said. "You have a tight supply squeeze on oil and energy prices, and some sectors where that passes through transparently like gas prices and airfare. But central banks usually don’t raise rates in response to oil price increases."

The hard and bad truth is that to get energy prices down in the short term we probably need to have the war in Ukraine magically resolve itself, drill for more oil, get more oil from places like Saudi Arabia, more fully open the U.S.'s strategic oil reserves, or ideally, demand that oil companies stop arbitrarily taking record profits. "More oil," though, is not politically palatable for progressives or anyone who cares about climate change.

"The only way to get oil costs down is to get more oil. But if you do that, you are burning more fossil fuels, which could help reduce oil and gas prices, but if you’re going to do that, the sort of way to thread the needle is like—well, inflation is too politically toxic to do nothing," Carter said. "So we can get oil prices down now but have to couple that with reducing long term demand for oil. Financing green energy stuff, nuclear power, making changes to the way people use electricity and all the rest. This is a real tough position for progressives to be in because there’s no goldilocks situation where everything works out great."

WHO THE HELL IS PAUL VOLCKER AND IS HE A KING OR A CLOWN?

All of this has a bunch of people talking about Paul Volcker, who was the Fed chair from 1979 through the 1980s. Inflation was very high in the late 1970s and early 1980s, and, in 1981, Volcker bumped the interest rate to an astonishing 20 percent, which more or less ended inflation but fucked over a lot of people and shot unemployment up to 11 percent. Keep in mind that the headlines you’re seeing today are about federal-funds rate rising to 1.5-1.75 percent.  

Volcker, who said that “the standard of living of the average American has to decline” in order to reduce inflation, is now seen as a folk hero to some and as a giant idiot or cruel person by others, but this crisis has a certain type of person suggesting we increase interest rates a lot and deal with a lot of short-term pain to basically "get it over with."

"The intellectual consensus is it was the brave, hard choice to make," Carter said of Volcker’s decision. "But it created a lot of pain. The unemployment rate went to double digits. He essentially engineered those layoffs. It was the Fed’s strategy because he believed price stability was the most important mission of the Fed. But at the time, it was very controversial."

With the benefit of hindsight, many people now believe what Volcker did was over the top, an abuse of power, and also not super effective: "Volcker is viewed by some as doing the hard thing nobody else wanted to do," Carter said. "But there's a significant community of professionals who say he went way overboard and abused his authority to pursue a conservative monetary policy."

Bear in mind that while macroeconomics is carried out by an ostensibly apolitical priesthood, it is as deeply political as anything in American life. The Reagan revolution—broadly, the complete triumph of capital over working people—was possible because to the extent that Volcker’s policies “worked,” they did so just in time for an economic boom timed to Reagan’s 1984 reelection campaign. As you evaluate what people are saying about whether what the Fed is doing is “working,” consider that some people will consider a crushing recession followed by a rapid pace of growth in 2024 to be just fine and others will want suffering and misery right up until about November 2024, for reasons having nothing to do with their abstract views on the Fed’s mandate or anything like that.

DON'T WORRY, THE CORPORATIONS AND RICH WILL BE OK

As I mentioned earlier, workers enjoyed a very brief period in which unemployment was very low, poverty declined, and inflation-adjusted wages increased in a real way for the first time in forever. During this period, I hope you bought a yacht, because it is ending. When corporate profits, cash on hand, and stock buybacks are at all time highs (which has been the case for much of the last decade), everything is going fine and the government and stock market is happy. When inflation goes high and wages go high and workers show any sign of having any power at all, however, the stock market gets angry, corporations get angry, investors get angry, etc. and it must be corrected via monetary policy (raising interest rates, basically).  

It doesn't necessarily have to be this way. Carter said that historically there have been other levers to pull, most notably corporate shaming, price negotiation, and "yelling at CEOs to lower their prices." (There are also other ways to increase worker power without subjecting the public to inflation taxes—the decline in unionization since Reagan’s time, which has a great deal to do with why America has become so unequal, is largely about public policy, and different public policy would achieve different results.) While Biden has talked about oil companies making record profits, he hasn't indicated that anything is going to be done about it. In the 1960s, President John F. Kennedy simply worked to shame companies into keeping prices lower and threatened to regulate them. "In the 1960s, the Kennedy administration would invite steel and car companies to the White House and say if you agree to keep prices at this level and wages at this level, everyone will be happy," Carter said. "The overall aim was to rein in inflation with means other than high interest rates."

ARE WE ALL SCREWED / HOW SCREWED ARE WE?

The thing everyone is hoping for right now is a "soft landing," which means, basically, some amount of short-term pain that allows us to avoid a full-blown recession, followed by a recovery, until we all do this again sometime. It is possible that this will still happen but it will be complicated and require a multifaceted, competent approach from not just the United States but the entire world. Inflation is a problem but it is not the only problem, as Carter said. 

"I think we should not rule out the possibility of a soft landing. They raise rates now which prevents further wage growth from adding to existing inflationary pressures, those pressures from energy ease as a result of better using our strategic petroleum reserve, or, if the U.S. and EU get a lot more serious about rerouting trade and resource extraction [buying oil and food from other places], then things like the War in Ukraine aren’t as disruptive to prices," Carter said. "So you do have this long standing issue you have to deal with, but it’s not like there’s no options. Those are hard and they require a comprehensive look from an environmental perspective, foreign policy perspective, and domestic labor perspective. The idea that inflation is the thing that has to be fixed is not necessarily wrong, but there are ways to bring it down that are themselves more politically palatable."