Convergence on Conflict? Blanchard, Krugman, Summers and Inflation

James K. Galbraith
Lloyd M. Bentsen Jr. Chair in Government/Business Relations at the LBJ School of Public Affairs at the University of Texas at Austin.
In 2010 he was elected to the seat formerly held by Paul Samuelson at the Accademia Nazionale dei Lincei.

“Does the Federal Reserve, at its highest levels, know these things? One can’t be sure about the economists. But the bankers at the Fed certainly do; it’s their business to know how the world really works. So what are they up to? A power struggle between oligarchs, is the obvious answer. Real estate, construction, tech and energy at the moment are losers; banks as always are among the winners. No surprise in this: the Federal Reserve works for the banks. The interest rate it sets is not natural in any sense: it is a weapon in the struggle. “Fighting inflation” is just a smokescreen for the real fight.”

In a widely-noted Tweet-storm on December 30, 2022, the senior neo-Keynesian economist Olivier Blanchard advanced — or more properly, resurrected — the thesis that inflation is always and everywhere a matter of social conflict. For disciples of Milton Friedman, this must have come as a shock. If inflation is not “always and everywhere a monetary phenomenon,” then dealing with it cannot be a merely technical task, a matter of monetary manipulations. Other policies are possible.

Paul Krugman quickly weighed in with a football analogy that I too remember from our years at Yale in the 1970s — though I think the original source was neither Martin Baily nor Bill Nordhaus but Thomas Schelling. The idea is that if everyone in the crowd stands, no one sees the game any better. If that precise analogy isn’t in Schelling’s 1978 Micromotives and Macrobehavior, the exact equivalent, raising one’s voice in a noisy room and adding to the noise — certainly is (p. 28).

Schelling’s point, which Blanchard and Krugman restate, was that social coordination can in principle reduce or even eliminate conflict-driven inflation, making everyone better off at little or no cost. Blanchard however offered no real-world examples — and a commenter pointed out that there were none in his textbook. Krugman remembers a rapid disinflation engineered in Israel many years ago, back when the Israeli Labor Party still existed in more than name.

Neither Blanchard nor Krugman seem aware — or willing to admit? — that coordinated anti-inflation policy has a rich history in the United States, the United Kingdom, Japan, Germany, France, Sweden, Austria, China and many other countries. The American experience includes price controls from 1942–1946 and 1950–1953, as well as under Richard Nixon in 1971 and 1973 (a case Krugman mentions). It includes the peace-time policy of wage-price guideposts under Kennedy and Johnson, limiting major union contracts to cost-of-living plus average productivity gains. It includes the (more nebulous) work of the Council on Wage-Price Stability, abolished only in the first week of Ronald Reagan’s presidency in 1981. For more details, see the work of Isabella Weber, who kicked off the new wave of price policy discussions over a year ago[1].

Ignoring this history, Blanchard declares that “in the end, forcing the players to accept the outcome, and thus stabilizing inflation, is typically left to the central bank.” He disapproves of this sad fact, writing that “one can/should dream of a negotiation between workers, firms and the state, in which the outcome is achieved without triggering inflation and requiring a painful slowdown.” But in his real world, the central bank’s actual job is to bludgeon workers, firms, homebuilders, and indebted households into submission. For this, the central bank has one weapon, the interest rate. It follows that anyone who profits from high interest rates will gain; everyone else must lose.

Blanchard’s tweets hit other leading economists with the force of catharsis. Echoes came quickly from a third grave public voice, Lawrence Summers. Apparently speaking from a palm-treed beach, Summers embraced conflict, brutally announcing that unemployment must rise as much as necessary until inflation ends. The Fed, Summers declared, is doing what exactly must be done.

All of which is quite amazing. While Blanchard is not a US national and has worked in public life only at the IMF, Summers, along with Jason Furman who holds similar views, is the leading economic tribune of the Democratic Party. Do they remember that their candidate lost the working class vote to Donald Trump back in 2016? And if Democrats continue to follow this line, what do they think will happen to them in 2024?

In making his basic case — short and simple though it was — Blanchard was not wrong. Another way is possible. Marc Lavoie and Louis-Philippe Rochon responded warmly on the theoretical merits, calling attention to work on incomes policy in the Post Keynesian tradition, which underpinned the Kennedy-Johnson guidelines policies and similar efforts in the United Kingdom. To their sources — Robert Rowthorn, Wynne Godley, Francis Cripps — I would have added an unjustly neglected book, Adrian Wood’s 1978 A Theory of Pay. Under these influences in my first book, Balancing Acts, in 1989, I proposed a means of coordinating wage bargains in the United States, precisely to reduce the distributive-conflict element of the inflationary process. It combined pay calendar synchronization — drawing on the easy passage of Japan through the 1970s oil price shocks — with what I called “Discretionary Prospective Indexation,” a form of forward guidance with teeth for wage settlements. Balancing Acts was well-reviewed in the Washington Post and New York Times, but drew no attention from academics or policymakers. The neoliberal revolution was still in full flower just then.

So yes, inflation is all about conflicts. It is not a matter of monetary mistakes, as Friedman claimed (though one may doubt he believed). The issue is, what kind of conflict? Between who and whom? And how can these conflicts be peacefully resolved?

On this issue, Blanchard is more subtle than either Krugman or Summers. He allows that wages may not be the main or only source of cost-push inflation. It could be commodity prices, such as oil. And he admits that other policies might be applied: “Through fiscal policy, [the state] can slow down the economy and eliminate the overheating. It can subsidize the cost of energy, limiting the decrease in the real wage and the pressure on nominal wages.” Well, yes, it can. However, a fiscal policy to throw people out of work is not better than a monetary policy pursuing the same goal. And a subsidy to the cost of energy could have the unwanted effect of supporting energy demand and driving up the price. So these concessions don’t amount to much.

Taken broadly, the vision of conflict-driven inflation, which is explicit in Lavoie and Rochon’s references to icons of the old Cambridge, imagines a country with industries and unions, of “countervailing power” in my father’s 1952 phrase, of capital and labor in the Marxian sense of ever-ongoing class struggles. This broad vision no longer describes the world in which we live. Conflict has not disappeared. But structural change and globalization have reorganized and redefined it.

In my 1989 book, I suggested a rough emerging hierarchy of nations: advanced technological (and I would now stress, financial) powers, intermediate manufacturing powers, and resource-based economies. The world has developed along these lines. In consequence, countries like ours (the US, UK, Canada) are now run by gangs of oligarchs, rooted in finance, technology, energy, aerospace, the military, big Pharma, insurance, real estate. Their struggles are mainly with each other. Labor as such has little-to-no leverage; it subsists on social minima, a strong currency, cheap energy, and (it must be said) the Schumpeterian gains from radical improvements in (mostly imported) consumer goods. For this reason, pressures for inflation are driven by resource costs, first and foremost, and after that by speculative competition between the various monopolists. As Josh Bivens has documented, the big recent gains are in profits. It’s an oligarch’s world, we only live here.

It is therefore a mistake, shared by Blanchard and his friendly Post Keynesian interlocutors, to tie the quasi-inflation of 2021–2022 to such ancient and battered notions as the “labor market,” the Phillips Curve, the Natural Rate of Unemployment or NAIRU, and the natural rate of interest. It is a mistake with consequences, reinforcing Summers, Furman and the Federal Reserve in the belief that misery will drive down costs and the prices of produced goods and services.

In today’s United States, manufacturing jobs account for less than ten percent of all employment. There are negligible jobs in mining or agriculture. A few, very well paid, are in technology and FIRE. The rest, an overwhelming majority, are in basic services. In the services sector, in a downturn, production lines don’t just stop; workers are not furloughed and then recalled. Service businesses are either open or they fail. So owners and operators take on debt, even on unsustainable terms, and try to keep going for as long as they can. Unemployment isn’t so easy to create, in the short run, as it once was.

When the crunch does come, as it must, wages and costs do not fall. Services wages are already at, or near, social minima. And it is much more difficult to replace service workers with new technologies (“robots”) when interest rates are high and the outlook is bleak. Moreover, where production lines (of a kind) are still relevant, as in warehouses and distribution networks, fixed costs predominate and unit costs rise when through-put declines. Keynes, by the way, already wrote about this in 1930.

Does the Federal Reserve, at its highest levels, know these things? One can’t be sure about the economists. But the bankers at the Fed certainly do; it’s their business to know how the world really works. So what are they up to? A power struggle between oligarchs, is the obvious answer. Real estate, construction, tech and energy at the moment are losers; banks as always are among the winners. No surprise in this: the Federal Reserve works for the banks. The interest rate it sets is not natural in any sense: it is a weapon in the struggle. “Fighting inflation” is just a smokescreen for the real fight.

And let’s not forget, these are American banks, and American bankers. The Federal Reserve’s policies are not — and never have been — purely domestic. By raising rates, they support the dollar, crush the euro, obliterate “emerging markets,” and throw major German and Swiss banks to the brink of crisis. Just as a non-dollar, non-euro zone is forming in Eurasia, the Federal Reserve is working to reassert the global dominance of the God-almighty Dollar. They may or may not succeed. But from their point of view, there is no conflict more important.

References

Galbraith, James K. 1989. Balancing Acts: Technology, Finance and the American Future. New York: Basic Books.

Galbraith, John Kenneth. 1952. American Capitalism: The Concept of Countervailing Power. Boston: Houghton Mifflin Company.

Keynes, John Maynard. 1930. “The Great Slump of 1930” in Essays in Persuasion. London: MacMillan.

Schelling, Thomas. 1978. Micromotives and Macrobehavior. New York: Norton.

Weber, Isabella M. 2021. “Could Strategic Price Controls Help Fight Inflation?” The Guardian, December 29, at https://www.theguardian.com/business/commentisfree/2021/dec/29/inflation-price-controls-time-we-use-it

Wood, Adrian, 1978. A Theory of Pay. Cambridge: Cambridge University Press.

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James K. Galbraith holds the Lloyd M. Bentsen, jr. Chair in Government/Business Relations at the Lyndon B. Johnson School of Public Affairs, The University of Texas at Austin. He was the staff person responsible for creating the Humphrey-Hawkins process of monetary policy oversight at the House Banking Committee in the 1970s, and served as Executive Director of the Joint Economic Committee in the early 1980s.

[1] Krugman makes a passing reference to a Wall Street Journal article on initiatives in Europe to cap the price of natural gas. The article, in turn, discusses the work of a Fall 2022 German commission on the point, on which Weber served. Her comments are quoted in the article: “‘I think this whole paradigm shift is happening here,’ she said. ‘The reason I was making these arguments early on was because I saw us heading into an emergency economic situation and others assume we are back on a path to a normal state.’”