Author
David Wilcox was a 22-year-old research assistant at the Federal Reserve Board of Governors when Fed Chair Paul Volcker started receiving two-by-fours in the mail, sent to him by homebuilders livid about the Fed’s repeated rate hikes that had crushed the construction sector. Angering the country’s builders was not the goal, of course, but cooling the economy was: Inflation had been trending upward for over a decade, reaching a high of 14.6 percent in March of 1980, the year Wilcox arrived for his first stint at the Board.
To get inflation under control, “Volcker was prepared to put the country through the wringer,” Wilcox recalls. “It was a tremendously painful experience for the country. And Volcker fully understood how painful it was.” This pain fueled frequent protests outside the Eccles Building, the home of the Board of Governors.
But neither the intimidating mail nor the intimidating state of the U.S. economy deterred Wilcox. Rather, the intensity of the moment stoked his interest to learn more. After earning his Ph.D. in economics from MIT, he chose to return to the Board, his professional home for the next 30 years. He retired from the Board in 2018 as director of the Division of Research and Statistics. Wilcox’s time at the Board, followed by affiliations with Bloomberg Economics and the Peterson Institute for International Economics, have given him a close-up view of the economic ups and downs the United States has experienced. From this vantage, Wilcox has synthesized keen observations about the role of the Fed and which lessons from the past will help promote a prosperous future.
Wilcox served as an inaugural member of the Institute’s advisory board, stepping down at the end of 2023 after six years of service. We spoke with him recently about the unusual economic events of the past four years, how labor market conditions affect different groups of workers, and why the stakes of increasing diversity of representation and thought in the economics profession are high.
Inflation dragons
What was it about your experience as a research assistant at the Board that made you decide to pursue a Ph.D. in economics?
By chance, I served as an RA at the Board during the height of Paul Volcker’s battle against inflation. The economy was really buckling under the weight of punishingly high interest rates, and the concern among the wise people that I had the privilege to work with was palpable. Their dedication and brilliance, combined with the importance of the issues they were wrestling with, convinced me that a career in economics would be an excellent choice for me.
One idea that drove Paul Volcker was the conviction that central banks actually have the means to control inflation. That idea was not by any means universally shared. Volcker’s predecessor by two as Chair of the Federal Reserve was a widely regarded, esteemed economist named Arthur Burns. Burns convinced himself that a central bank operating in a democratic society lacked the means to bring inflation under control, that the corrective measures would be so painful that society would rebel and bring an end to the independent central bank as an institution. Burns was convinced that he was powerless as Chair of the Federal Reserve to end the inflation. In other words, it wasn’t his fault.
Volcker didn’t believe that for a moment. And as we now know, he was right: By raising interest rates, the Fed was able to bring inflation down. While the remedy was tremendously painful, Volcker deeply believed that the economy functioned better when inflation wasn’t a major consideration for households or businesses, and he believed the pain that would be required to bring it down would be a cost worth paying, because it would pay dividends many years into the future.
The way you describe the public’s reaction to what was happening in the 1980s brings to mind news stories of the past year, which have reported that people are angry both at high prices and at high borrowing costs. Do you see parallels between the situation in the 1980s and the situation today?
The anger at the Fed today is real and it’s understandable. People experience price increases as money that has been taken away from them. Moreover, most people don’t connect the inflation that they’re experiencing at the grocery store or the gas pump to the fact that they may have gotten a bigger pay increase in the past couple of years than they would have in the absence of the inflation.
Without minimizing the anger or the pain today, I would assert that it was so much worse in the early 1980s. Today a remarkable fact of the economic situation is that the labor market remains very strong, and that simply was not the case 40 years ago when Volcker and his colleagues on the FOMC [Federal Open Market Committee] were bringing inflation down.
The lesson I think we’ll all take away from the past 40 years—including the COVID era—is that it’s extremely important to keep inflation low and stable. We see time and again how bitterly angry the American public becomes when inflation gets out of control—and they’re not wrong to be angry. Job one for the Federal Reserve System right now is to slay the inflation dragon and do it decisively, well and truly.
Economic derangement
The past four years have been particularly unusual for the U.S. economy. What other lessons do you feel you have learned about the economy, and are there other lessons the Fed should be learning?
A lesson that strikes me as most important about the past four years is that the economy sometimes departs from its normal behavior and goes into a mode of economic derangement. It doesn’t operate according to the normal patterns of behavior that we grow used to in the much more frequent and long-lived periods of relative tranquility.
Let me give an example of that. In normal times, if you want to bring inflation down, you’ll almost surely have to push unemployment way up, just like Volcker did. You need to weaken the pricing power of companies, so they don’t have the ability to push price increases onto their customers. You also need to erode the bargaining power of workers, reducing their ability to demand wage increases, which would probably be passed on into further price increases.
But think about what we’ve seen since roughly the middle of 2022. We’ve seen a dramatic reduction in inflation, and the labor market has remained strong. The unemployment rate has edged up only a little, and it remains low by historical standards.
What I draw from this is that everybody who cares about understanding the American economy at a deep level needs to be on the lookout for periods when the economy stops behaving normally and the conventional models that usually have decent predictive accuracy need to be set aside. They don’t need to be junked. They just need to be set aside because there will come a time when it’s appropriate to reach for those models, bring them back off the shelf and ask, Gee, are we back in normal times?
One of the next key challenges for the Federal Reserve and lots of other people will be to have a keen eye out for when the economy has resumed behaving in a more normal manner. But this basic phenomenon that economies can “phase shift” from normal mode to abnormal mode—that’s one of my key takeaways.
You pointed out that the U.S. has had a strong labor market following the post-COVID recession. You’ve studied how different groups of workers are affected when labor markets are particularly strong versus weak. What does that research show?
Research on the benefits of a tight labor market dates back at least to the work of economist Arthur Okun. The main reason why tight labor markets are so beneficial is that they improve the bargaining power of workers, and workers in the United States are in a pretty weak position. We don’t have strong collective bargaining. The role of unions has declined a lot. In weak labor markets, employers are really in the driver’s seat.
In a hot labor market, all of a sudden it turns out that employers need to compete for workers on the basis of better wages, more expansive benefits, maybe better hours, more predictable hours. In a hot labor market, employers suddenly find it much more costly to indulge a predilection they might have for discriminating by gender, race or ethnicity, or other characteristics unrelated to a person’s ability to do the job. Suddenly in a hot labor market, many employers say to themselves “I need qualified workers. I don’t care if they look like me. I care that they’re capable of performing the job responsibilities and doing them well.” Workers suddenly can become choosers among various different opportunities. A hot labor market of course is beneficial to people up the income ladder, but it’s disproportionately beneficial to people further down the economic ladder.
The sad fact of the story, however, is that when labor markets weaken again, many of those benefits that briefly accrued to these disadvantaged groups, those benefits erode. It’s not permanent. What is best for workers is a sustained period of strong labor markets. That’s the main mechanism.
The tyranny of compound arithmetic
Earlier this year, you wrote an article for Bloomberg about the trajectory of U.S. government debt. In the article, you expressed concern that the Congressional Budget Office’s projections, which aren’t exactly rosy, may actually be too optimistic, and that government debt may reach 120 percent of GDP within the next 10 years. What is the risk to the U.S. economy if government debt continues its climb?
Well, the risk is that we’ll be pumping too much federal debt into financial markets and that at some point, investors will conclude the U.S. Treasury may not be good for its promises to repay in full. Until now, the credit worthiness of the U.S. Treasury has been essentially unquestioned, and that’s likely to remain the case in the near future. There is an issue on the horizon, however, or really, an aggregation of issues. With an aging population, we’ll have a larger percentage of our population receiving Social Security and Medicare benefits. With a more hostile geopolitical environment, we’re likely to spend more on defense rather than less. With a divided government and an environment in which taxes are never popular, Congress is especially gridlocked in enacting any new revenues. With all that, the risk is that the gap between spending and revenues will remain wide and may grow even wider.
That risk is made much worse by the possibility that we may not return to the environment of low interest rates that prevailed before COVID. Interest rates are incredibly important in this space because interest rates are the price of borrowing, so when rates are low, borrowing is cheap. When rates are higher, borrowing is no longer on sale. The tyranny of compound arithmetic is such that higher rates today become like a snowball rolling down a hill, and eventually it creates an avalanche.
The fear is that at some point financial markets will look at this combination of circumstances and conclude this situation simply cannot be sustained, and 10 years from now, there is going to be too much U.S. Treasury debt on the market and investors will have a rebellion. But the forward-looking nature of financial markets is such that if they conclude there will be a rebellion 10 years from now, the chances are very high there will be a rebellion today. That’s a recipe for a government debt crisis.
The way out is that policymakers need to recognize that the situation is very serious. In this case, hope is not a strategy. The probability of the U.S. fiscal situation ending up on a sustainable trajectory just by waiting for enough good luck to occur is a very implausible strategy.
You’ve described this in a very measured way, but at the same time this feels very serious. Is this something that keeps you up at night?
Do I lose sleep over this? The answer is no. Historically, the country has always risen to meet difficult challenges and there’s no reason why this challenge can’t be met. So I don’t think it’s a reason for unbounded concern today. I do think it’s a reason for focus. It’s a reason for politicians to grit their teeth and recognize that the situation is a serious one. As out of style as it may be in today’s day and age, there’s going to have to be some give from both sides. The overwhelming likelihood is that revenues are going to have to be raised.
On the other hand, it’s also the case that we’re demanding too much from our government at the moment, and so there’s going to have to be some give on the spending side as well, and there simply isn’t enough spending of the kind that most people think they could do without, like national parks or foreign aid, that would come close to solving this problem. The actions that would realistically solve this problem are painful, but they’ll only become more so the longer we wait to address the situation.
Opening the doors to the economics profession
You’ve been an economist for 35 years. How has the economics profession evolved in that time—or failed to evolve?
For too long, since I’ve been involved in economics and for a long time before that, there’s been a profound misunderstanding about what economics is and who is supposed to be an economist. Too many people think that economics is only about investing in stocks or bonds, that sort of thing. A much more accurate view is that economics is about the equitable and efficient distribution of health care. It’s about facilitating the transition away from carbon fuels to renewable energy in an efficient and sufficiently timely manner that we prevent the global environment from imploding. Economics is about understanding what makes certain cities and certain neighborhoods vibrant places to live, recreate, and work, and what makes some cities and neighborhoods, unfortunately, models of failure. Economics is about tough choices between generations and how much we should spend to support the elderly versus how much we should spend to invest in the well-being and creative potential of the youngest generations. Economics is about the factors that influence our daily well-being and the well-being of every member of society, and therefore it’s vastly too important to be left only to people who look like me: a White male from a privileged background. Economic analysis is deeply enriched when we have people coming at difficult problems from many different perspectives, ideally from all the different perspectives that are represented in society as a whole.
The magazine of the opportunity & Inclusive Growth institute
An interesting aspect of economics is that it’s different from particle physics, it’s different from algebra or geometry, in that I really don’t think there is a male version of algebra or geometry or a female version of algebra or geometry. Regardless of your personal characteristics, the theorems are the same and the basic approach to proving those theorems is the same.
Economics is not like that. The problems that we choose to study, the papers that we publish in our journals, the professors that we choose to promote to the rank of associate professor and full professor and department chair—all of those choices depend critically on our assessment of what the most important problems are.
The sad fact of the matter is that we’ve made much too little progress in opening wide the doors of economics. The stakes are high because the functioning of society depends on getting this right, and we’re still a long way from getting it right.
This article is featured in the fall 2024 issue of For All, the magazine of the Opportunity & Inclusive Growth Institute
Lisa Camner McKay is a senior writer with the Opportunity & Inclusive Growth Institute at the Minneapolis Fed. In this role, she creates content for diverse audiences in support of the Institute’s policy and research work.
