Further interest-rate hikes to fight inflation will worsen inequality. And they’re unnecessary.

Mar 7

Robert Reich

Mr. Powell,

As chairman of the Federal Reserve Board, you’re making your semi-annual policy report today to Congress.

I hope you don’t think me impertinent, but I have an urgent question for you that I hope one of the senators asks: How can you justify further rate hikes in light of America’s staggering inequality?

You and your colleagues on the Fed’s Open Market Committee are considering pushing interest rates much higher in your quest to get inflation down to your target of 2 percent. You believe higher interest rates will reduce consumer spending and slow the economy.

With due respect, sir, this is unnecessary, and it would be unjust.

Over the past year, you’ve raised interest rates at the fastest pace since the 1980s, from near zero to more than 4.5 percent.

But consumer spending isn’t slowing. It fell slightly in November and December but jumped 1.8 percent in January, even faster than inflation.

As a result, you’re now saying you may need to lift rates above 5 percent. A recent paper by a group of academic and Wall Street economists suggests that you will need to raise interest rates as high as 6.5 percent to meet your 2 percent target.

This would worsen America’s already staggering inequalities.

You see, the Americans who are doing most of the spending are not the ones who will be hit hardest by the rate increases. The biggest spenders are in the top fifth of the income ladder. The biggest losers will be in the bottom fifth.

Widening inequality has given the richest fifth a lot of room to keep spending. Even before the pandemic, they were doing far better than most other Americans.

Their current spending spree is a big reason you and your colleagues at the Fed are having so much difficulty slowing the economy by raising interest rates (in addition to the market power of many big corporations to continue raising prices and profit margins).

The higher rates are flowing back into the top fifth’s savings, on which they’re collecting interest.

The top fifth’s savings are still much higher than they were before the pandemic, so they can continue their spending spree almost regardless of how high you yank up rates. Take a look at this chart:

(Sources: J.P. Morgan Private Bank, Haver Analytics. Data as of October 2022.)

But yank up rates and you’ll impose big sacrifices on lower-income Americans. The study I mentioned a moment ago concludes that “there is no post-1950 precedent for a sizable central-bank-induced disinflation that does not entail substantial economic sacrifice or recession.”

There’s also no post-1950 precedent for the degree of income inequality Americans are now experiencing.

The people who will endure the biggest sacrifices as the economy slows will be the first to lose their jobs: mostly, those in the bottom fifth. Relying on further interest-rate hikes to fight inflation will only worsen the consequence of America’s near-record inequality.

There’s no reason for further hikes, anyway. Inflation is already slowing.

I understand your concern, Mr. Powell. What looked like a steady albeit gradual slowdown is now looking even more gradual.

But so what? It’s the direction that counts.

You should abandon your 2 percent target rate of inflation. There’s nothing sacrosanct about 2 percent. Why not 4? Getting inflation down to 2 percent is going to cause too much pain for the most vulnerable.

And you should suggest to Congress that it use other tools to fight inflation, such as barring corporations with more than 30 percent market share from raising their prices higher than the overall inflation rate — as recently proposed by New York’s attorney general.

May I be perfectly frank with you, sir? It would be terribly unjust to draft into the inflation fight those who are least able.

Thank you.

Robert Reich