In a ground-breaking article earlier this week, Jon Hilsenrath of the Wall Street Journal showed that one can’t even guess at the outcome of unprecedented accommodative monetary policy without factoring also the impact of fiscal stimulus unseen since the Great Depression. As I told Jon, these two juggernauts are not only steaming towards each other, but plowing ahead regardless of seas made stormier by economic inequality at ever steeper heights. The Fed for example thinks inflation is “transitory” because it measures inflation without regard to income inequality. When inflation is understood as purchasing power – the measure the law demands – it’s clear not only that inflation isn’t transitory, but also that it’s very, very worrisome.
Much in current monetary policy is premised on what economists call the marginal propensity to consume – i.e., the engine of want that powers demand that then promotes employment and growth or, if unduly over-heated, sparks inflation. The Fed assumes to this day that interest rates drive decisions about how to use discretionary income, but the inexorable vise of income and wealth inequality means that now only upper-income households have this marginal propensity and most of them have more than enough already so their propensity is small even if their margin is large. In sharp contrast, low-, moderate-, and middle-income families do the bulk of U.S. consumption but they have little capacity to increase or shrink it in response to changing rates because most of them live paycheck to paycheck. Thus, when prices go up – even a little – these families take on more debt or go without basic goods and services. As we’ve noted before, even about a quarter of middle-class households skipped medical treatments in 2019 because they just couldn’t pay the bill.
How much purchasing power do most Americans actually have? To know the answer, you have to look not just at the Bureau of Labor Statistics’ CPI or the Fed’s preferred index, the PCE. You have to look at whether a family sustains household security and a little bit of the comfort that once defined the middle class on middle-class wages. Measured this way, recent price hikes are indeed inflationary and unlikely to be any more transitory than those that came before during years of ultra-accommodative policy.
Understanding what purchasing power really means, the Federal Reserve Bank of Cleveland in 2020 looked at all of the most recent studies of the U.S. middle class, comparing the 2018 middle class to the far more vibrant one in the U.S. of 1980 before inequality began to accelerate. Looking at real median household income for working-age adults and recalculating it to reflect higher consumption costs, this study corrects for problems such as U.S. demographic shifts and over-simplified income measures that do not reflect recent hikes in the cost of living. Differing sharply from the Fed’s happy view of monetary policy’s beneficial impact on wage growth, the study finds “fairly flat” real income growth for the working-age middle class as a whole, but much of this is due to the growth of two-income households and all of it is eviscerated when the cost of health care and housing is taken into account. These costs increased more than nominal middle-class income from 1980 to 2018, with the cost of education alone over this period increasing an astonishing 600 percent.
Could the price increases the Fed deems transitory really evaporate in puffs of expensive smoke when the pandemic recedes? I doubt it.
For example, the cost of a home isn’t directly reflected in any of these indices. However, house-price appreciation hit a stunning year-over-year increase of twelve percent. If we’re lucky and there isn’t a bursting bubble, there may well be a gradual appreciation deceleration. All this will do, though, is make housing a little less unaffordable, not ensure that low-, moderate-, and even middle-class families can afford the kind of housing that stokes sustained demand, bottom-up employment, and shared prosperity.
What about other must-haves? Food prices are up 2.4 percent year over year and medical costs are up about as much. Used-auto prices are up an astonishing 21 percent and, while some of this may well be due to acute semiconductor shortages stifling new-car supply, it’s unlikely that car prices will decline back to pre-COVID levels absent a recession – one way of course to cure inflation the way the Fed thinks of it but of course no palliative for the all-essential purchasing power.
Worse still, the rising household income on which the Fed counts to prevent family financial hardship due to rising prices is up largely due to larger gap between the haves and have-nots. As the Fed’s April FOMC minutes note, 8.4 million Americans still don’t have the jobs they did in March of 2020. And, even if the end of transfer payments moves every worker now on the sidelines back into the labor force – unlikely given small-business devastation – wages are still flat and thus no buffer against even a slight rise in the cost of essential goods and services. Looked at distributionally, real median wages have stayed essentially flat over the past twenty years. For these families, inflationary pressures are acute and consumption will thus diminish in concert with still more debt at still greater risk to household and financial stability.
Will fiscal policy push us off this monetary-policy precipice? Transfer payments will reduce income inequality, but not enough to spur real purchasing power. Simply put, U.S. economic inequality is so deeply entrenched that even ultra-progressive fiscal policy can’t do enough without the added power of equitable monetary policy.