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The Role of the Federal Reserve System in Keeping Wages Low

Michael Perelman (michael.perelman [at] teaches economics at California State University at Chico. His many books include Railroading Economics and The Invisible Handcuffs of Capitalism, both published by Monthly Review Press.

Author’s Note: My book The Invisible Handcuffs of Capitalism (Monthly Review Press, 2011), from which this article is adapted, tells the story of how orthodox economists have systematically excluded all consideration of work, workers, and working conditions from mainstream economic theory, as well as the damage created as a result of that distortion. Neoclassical economists are concerned about the workers’ transactions with capital, but they care little about the workers themselves or their working conditions. Workers merely accept a wage bargain, go to work, and finally collect a wage. What happens at the workplace is irrelevant. The wage bargain is presumed to be voluntary, agreeable to both workers and their employers. In fact, the relationship between labor and capital is anything but voluntary. Capitalism uses a variety of weapons to make labor conform to its needs. The book compares this control to a Procrustean bed. According to Greek legend, Procrustes was an innkeeper who made his guests fit into an iron bed. He stretched the short ones and amputated the tall ones until they were the proper dimensions. Monetary policy is a Procrustean weapon. What follows is adapted from the book. It tells the story of how the Federal Reserve System sadistically wields monetary policy to keep wages low.

Economist Edwin Dickens has written a series of significant articles analyzing the minutes of the meetings, dating back to the 1950s, of the Open Market Committee of the Federal Reserve Board. (The Committee is the main policy-making body of the Board.) Dickens’s research shows convincingly that the Federal Reserve’s partisan behavior is designed to tilt the economy in the direction of the wealthy by making workers more compliant.

Dickens reported numerous occasions when participants voted to tighten the money supply just before major union contracts were about to expire. The minutes indicate that the specific intent was to force employers to be less generous with their wage offers during contract negotiations.1

A recent study formalized Dickens’s work by attempting to distinguish whether the policy actions of the Federal Reserve were responses to inflation or to low unemployment. The study concluded that “a baseless fear of full employment,” rather than the prevention of inflation, was the guiding principal of the Federal Reserve.2 The conclusion of this study should come as little surprise to people familiar with the Federal Reserve’s obsession with the danger of high wages.

Defenders of such policies justify the temporary restriction of job creation, contending that the Federal Reserve is merely trying to curb excessive growth. According to this school of thought, the Federal Reserve is simply preventing the kind of excesses that lead to severe recessions or depressions. Slowing down growth today may be necessary to provide for a higher sustainable growth rate in the future. Most economists argue that the cumulative effect of even a fairly small increase in growth rate can be substantial—more than enough to compensate for a temporary slowdown.

The defenders are wrong. Periodic slowdowns that the Federal Reserve engineers to undermine wage growth are unlikely to stimulate economic growth. In fact, according to a study by the Bank for International Settlements, slowdowns actually seem to diminish, rather than promote, long-term growth.3 Over and above the dramatic effects of intentionally engineered slowdowns, the steady effort to keep wages in check also probably reduces the rate of growth. As economists continually warn, the cumulative effect of a reduced rate of economic growth can be substantial. This loss must count as another cost of Procrusteanism.

In the 1920s, John Maynard Keynes described the effect of this sort of monetary policy on workers: “the object of credit restrictionis to withdraw from employers the financial means to employ labour at the existing level of wages and prices. The policy can only attain its end by intensifying unemployment without limit, until the workers are ready to accept the necessary reduction of money wages under the pressure of hard facts.”4 Keynes’s description of this policy seemed to frame it as a form of Procrustean class warfare. “Those who are attacked first are faced with a depression of their standard of life, because the cost of living will not fall until all the others have been successfully attacked too; and, therefore, they are justified in defending themselvesthey are bound to resist so long as they can; and it must be war, until those who are economically weakest are beaten to the ground.”5 Keynes concluded, “It is a policy, nevertheless, from which any humane or judicious person must shrink.”6

The Federal Reserve’s fight against wages can be intense. In 1979, shortly after taking the reins at the Federal Reserve, Paul Volcker announced new operating procedures and a determination to hold inflation in check. At first, many powerful people doubted whether Volcker would be willing to follow through with his plans, which were sure to create enormous casualties. A front-page story in the Wall Street Journal, “Monetary Medicine: Fed’s ‘Cure’ is Likely to Hurt in Short Run by Depressing Economy, Analysts Say,” expressed this sentiment. The paper noted, “Among those who are skeptical that the Fed will really stick to an aggregate target is Alan Greenspanwho questions whether, if unemployment begins to climb significantly, monetary authorities will have the fortitude to ‘stick to the new policy.’”7

Around this time, and possibly in response to the article, Volcker invited the editor of the paper’s editorial page, his deputy, and the features editor to a lunch at the New York branch bank of the Federal Reserve. Volcker asked his guests, “When there’s blood all over the floor, will you guys still support me?” The deputy editor responded affirmatively, later proudly recollecting, “There was blood indeed, as overextended Latin borrowers and American farmers were caught out by a return to a sound dollar. But we held fast.”8

Volcker’s militaristic analogy (expressed privately to the staff of the Wall Street Journal) let the cat out of the bag. The effort to tame inflation was, in reality, mostly a class war. In fact, Volcker himself had intended to spill blood. He expressed his intentions in another way:

[Volcker] carried in his pocket a little card on which he kept track of the latest wage settlements by major labor unions. From time to time, he called various people around the country and took soundings on the status of current contract negotiations. What is the UAW asking for? What does organized labor think? Volcker wanted wages to fall, the faster the better. In crude terms, the Fed was determined to break labor.9

Volcker tightened the money supply to such an extreme degree that the United States experienced what was then the worst economic downturn since the Great Depression. Volcker only let up when the collateral damage became too great. Mexico, which owed a great deal of money to U.S. banks, seemed to be on the brink of bankruptcy, thereby threatening the U.S. banking system. Citibank was effectively bankrupt.

Later Michael Mussa, director of the Department of Research at the International Monetary Fund, looked back fondly at Volcker’s accomplishment. Mussa continued the military analogy, praising Volcker’s victory in vanquishing “the demon of inflation”: “The Federal Reserve had to show that when faced with the painful choice between maintaining a tight monetary policy to fight inflation and easing monetary policy to combat recession, it would choose to fight inflation. In other words to establish its credibility, the Federal Reserve had to demonstrate its willingness to spill blood, lots of blood, other people’s blood.”10

Interestingly, the intended enemy of this war—the workers—went unmentioned in this recollection, as did the collateral damage to farmers and the Latin Americans. But what had workers done to make the state treat them as enemies? Were these people culpable of some evil act for wanting more than a pittance?

The Federal Reserve serves the needs of the powerful. Its role is to protect capital against the interests of labor. In order to maintain labor discipline, the Federal Reserve Board is entrusted with the task of maintaining a level of unemployment high enough to keep workers fearful of losing their jobs.

Just compare the bloodlust of those leading the attack on labor with the lax disciplinary mechanisms for the corporate elite. Based on an extensive survey of major corporations, Michael Jensen, a professor emeritus at Harvard’s Graduate School of Business, found 94 percent of all contracts for chief executives prevent them from being fired for unsatisfactory work without a big severance package. In 44 percent of the contracts, this protection even included those convicted of fraud or embezzlement.11 This should be a national scandal. As Warren Buffett told his shareholders, “Getting fired can produce a particularly bountiful payday for a CEO. Indeed, he can ‘earn’ more in that single day, while cleaning out his desk, than an American worker earns in a lifetime of cleaning toilets. Forget the old maxim about nothing succeeding like success: Today, in the executive suite, the all-too-prevalent rule is that nothing succeeds like failure.”12

Soon afterward, Stanley O’Neal proved Buffett to be correct. In 2007, after announcing an initial estimate that his firm had lost almost $8 billion that quarter, Merrill Lynch let him go with $161.5 million in stock, options, and other retirement benefits. One compensation expert said, “I wish my performance was so bad that I could get $160 million to leave.”13 As the economic crisis unfolded, O’Neal’s successor, as well as a host of other failed executives, collected comparable rewards.

Sado-monetarism is not so much a matter of monetary discipline, as most economists would have it, but of class discipline. In the 1960s, Harry Johnson, a conservative professor from the University of Chicago, writing in a journal dominated by the conservative perspective of his school, offered a shockingly honest evaluation of the class bias of monetary policy. “From one important point of view, indeed, the avoidance of inflation and the maintenance of full employment can be most usefully regarded as conflicting class interests of the bourgeoisie and the proletariat, respectively, the conflict being resolvable only by the test of relative political power in the society and its resolution involving no reference to an overriding concept of the social welfare.”14

The level of unemployment provides a rough indication of the difficulty of getting a new job. But what about the probability of getting an equally desirable job? Recent economic changes have made such prospects increasingly unfavorable. In today’s job market, losing a well-paying job generally means downward mobility—having to settle for less-desirable employment in the future.

Not surprisingly, unemployment takes a heavy toll on people’s psyche. Unemployment and the threat of future downward mobility mean humiliation not only for the worker, but also for the entire family. Losing access to what one considers a normal level of consumption can be a wrenching family experience. Children and spouses suffer embarrassment when they are unable to afford the kind of consumption to which they had become accustomed. Being unemployed is more stressful than divorce or marital separation.15 People can get over the pain of divorce or separation, but the psychological toll of unemployment lingers.

Psychologists have found that people who have lost a limb are naturally unhappy about their condition, but, after a while, they return to their previous level of happiness. But the unemployed do not. Richard Layard, a highly-respected British economist who recently turned to the subject of happiness, observed, “So unemployment is a very special problem. Moreover, it hurts as much after one or two years of unemployment as it does at the beginning. In that sense you do not habituate to it (though it hurts less if other people are out of work too). And even when you are back at work, you still feel its effects as a psychological scar.”16

Psychologists also know that dread—the anticipatory fear of a likely experience—can be even worse than the event itself. So long as workers feel a strong dread of unemployment, a lower threshold of unemployment will be sufficient to make workers compliant.

This psychological knowledge played an important role in setting economic policy during the late 1990s. At the time, the economy was growing. Low interest rates first fueled the bubble, and then, after its collapse, led to the housing bubble. Unemployment was creeping downward. Wages were increasing, but only modestly. Even so, business feared that unemployment was headed to dangerously low levels. Yet Alan Greenspan, Chairman of the Federal Reserve Board, refused to increase interest rates, knowing that despite lower unemployment, the dread of unemployment (engendered by the memories of more than twenty years of successful employer and government class warfare) by itself was sufficient to keep wages in check.

One major factor in the intensification of dread was the effect of globalization. Greenspan understood that he did not have to use the powers of the Federal Reserve to create unemployment. The pool of unemployment had expanded to include hundreds of millions of workers outside the United States. Workers who make strong demands are likely to be met by an employer threat to move production offshore. In this environment, the dangers of higher wages and declining labor discipline were insignificant. This realization gave Greenspan confidence to keep interest rates low. The high stock market and housing prices were not a matter of concern for him.

Greenspan’s confidence was a reflection of what George Orwell called “the haunting terror of unemployment.” In Orwell’s words, “the working man demandsthe indispensable minimum without which human life cannot be lived at all. Enough to eat, freedom from the haunting terror of unemployment, the knowledge that your children will get a fair chance.”17

Greenspan explained his monetary strategy in similar, but less eloquent, terms, bluntly noting the state of what he called the “traumatized worker.” He was not referring to the traumatization of the unemployed workers, but rather that of the employed workers who dreaded the possibility of unemployment. Traumatization refers to a condition that causes people to suffer serious disorders—the kind with potentially grave consequences. The association of post-traumatic stress disorder and the threat of unemployment might seem farfetched, if the source were someone less eminent than Alan Greenspan.

As Robert Woodward reported, Greenspan saw the traumatized worker as “someone who felt job insecurity in the changing economy and so was resigned to accepting smaller wage increases. He had talked with business leaders who said their workers were not agitating and were fearful that their skills might not be marketable if they were forced to change jobs.”18

With wages held in check while the economy boomed, inequality soared during the late 1990s. In 1997, responding to a question from Representative Patrick Kennedy, Greenspan, who made a science of public evasiveness, blamed the resulting growth in inequality on technology and education, while excusing his own contribution. “It is a development which I feel uncomfortable with. There is nothing monetary policy can do to address that, and it is outside the scope, so far as I am concerned, of the issues with which we deal.”19

I do not believe that Greenspan ever used the expression “traumatized worker” in his public pronouncements. He always chose his words carefully, and he perfected a language that was legendary for its obscurity. Still, his less inflammatory words conveyed the same message. For example, he testified before Congress that, “The rate of pay increase still was markedly less than historical relationships with labor market conditions would have predicted. Atypical restraint on compensation increases has been evident for a few years now and appears to be mainly the consequence of greater worker insecurity.”20

Greenspan was correct in his assessment of the situation facing workers. He had numbers to back him up, reporting that, “As recently as 1981, in the depths of a recession, International Survey Research found twelve percent of workers fearful of losing their jobs. In today’s tightest labor market in two generations, the same organization has recently found thirty seven percent concerned about job loss.”21

Greenspan was not the only official at the Federal Reserve who appreciated the benefit of low unemployment without wage increases. One of the governors of the Federal Reserve, Edward W. Kelley, Jr., spoke up at a meeting of the Open Market Committee about “the good results that we are getting now.” He went on to say:

I don’t know how much, (sic) has to do with the so-called traumatized worker. How long is the American workforce going to remain quiescent without the compensation increases that it thinks it should get? When employment is as strong as it is right now, I don’t think we can depend on having permanently favorable results in that area. This has been a rather big key to the present happy macro situation where we have a high capacity utilization rate and a relatively low inflation rate. We all feel rather good about that.22

Economists also realized what was happening to labor. Not long after Greenspan’s comments about identifying speculative bubbles, Nobel Laureate Paul Samuelson told a conference sponsored by the Federal Reserve Bank of Boston that “America’s labor force surprised us with a new flexibility and a new tolerance for accepting mediocre jobs.”23

Work stoppages offer a quantitative measure that suggests how effectively labor was tamed. Between 1966 and 1974, the number of work stoppages involving 1,000 workers or more never fell below 250. The average was 352, with a peak of 424 in 1974. Work stoppages then began to fall off rapidly, reaching a low point of fourteen in 2003, and rising slightly to twenty-one in 2007.24 Then as the economic crisis took hold, many workers had to accept serious declines in wages and benefits.

And while one might expect that lower wages would cut into consumer demand, according to a study in the Journal of Consumer Research, “people use consumer purchases to compensate for psychological states of insecurity.”25 Many families had to take on considerable debt to maintain their standard of living, and this debt reinforced the dangers of unemployment.

Workers’ acceptance of mediocre jobs at modest wages paid handsome dividends for business, creating more demand (through debt), while making workers even more fearful of losing their jobs. In addition, workers’ insecurity also meant that they were less likely to quit in search of better employment, allowing employers to avoid the costs of recruiting and retraining replacement workers. Perhaps best of all, employers could enjoy this bounty without having to call upon the Federal Reserve to slow down the economy.

Of course, the stresses and fears of traumatization will probably interfere with performance on the job, although business is not likely to notice. After all, work, workers, and working conditions remain far from view as long as workers give no indication that they are not following orders.

William McChesney Martin, chairman of the Federal Reserve between 1951 and 1970, used to say that the job of the Fed was to take away the punch bowl when the party gets going. With labor traumatized, the Federal Reserve no longer had to maintain a watchful eye over the economy. Instead, the Fed carelessly spiked the punch bowl with low interest rates and limited oversight of the financial system, fueling a series of bubbles during the Greenspan years.

The bursting of those bubbles ultimately traumatized much of the world. Although Greenspan was confident that labor was in no position to challenge capital, much of the rest of the economic punditry were still obsessed with keeping labor in check—so much so that they were unable to pay attention to the impending disaster.

In stark contrast to the sadistic attitude toward labor, when speculative excesses or some other miscalculation create adverse economic conditions that threaten to harm powerful business interests, especially in finance, the Fed is almost certain to rush in to the rescue. Then, they will throw money at business interests—hanging labor out to dry.


  1. Edwin Dickens, “The Great Inflation and U.S. Monetary Policy in the Late 1960s: A Political Economy Approach,” Social Concept, 9, no. 1 (July 1995): 49–82; and “The Federal Reserve’s Tight Monetary Policy during the 1973–75 Recession: A Survey of Possible Interpretations,” The Review of Radical Political Economics, 29, no. 3 (Summer 1997): 79–91.
  2. James K. Galbraith, Olivier Giovannoni, and Ann J. Russo, “The Fed’s Real Reaction Function Monetary Policy, Inflation, Unemployment, Inequality, and Presidential Politics,” Levy Economics Institute Working Paper no. 511, August 2007,
  3. Valerie Cerra and Sweta Chaman Saxena, “Growth Dynamics: The Myth of Economic Recovery,” American Economic Review 98, no. 1 (March 2008): 439–57.
  4. John Maynard Keynes, “The Economic Consequences of Mr. Churchill (1925),” in Essays in Persuasion, vol. 9: The Collected Works of John Maynard Keynes, ed., Donald Moggridge (London: Macmillan, 1972), 218.
  5. Ibid., 211.
  6. Ibid., 218.
  7. Wall Street Journal, October 9, 1979.
  8. George Melloan, “Some Reflections on my 32 Years with Bartley,” Wall Street Journal, December 16, 2003.
  9. William Greider, Secrets of the Temple (New York: Simon and Schuster, 1987), 429.
  10. Michael Mussa, “U.S. Monetary Policy in the 1980s,” in Martin Feldstein, ed., American Economic Policy in the 1980s (Chicago: University of Chicago Press, 1994), 81, 112.
  11. Louis Uchitelle, “Advocate of Paying Chiefs Well Revises Thinking,” New York Times, September 28, 2007.
  12. Warren Buffett, “Annual Letter to the Shareholders of Berkshire Hathaway Inc. 2005,” http://
  13. Walter Hamilton and Kathy M. Kristof, “Merrill Lynch Chief Resigns,” Los Angeles Times, October 31, 2007,
  14. Harry G. Johnson, “Problems of Efficiency in Monetary Management,” Journal of Political Economy 76, no. 5 (September 1968): 986.
  15. Andrew E Clark and James J. Oswald, “Unhappiness and Unemployment,” The Economic Journal 104, no. 424 (May 1994): 658.
  16. Richard Layard, Happiness: Lessons from a New Science (New York: Penguin Press, 2005), 67.
  17. George Orwell, “Looking Back on the Spanish War (1943),” in The Collected Essays, Journalism and Letters, vol. 2: My Country Right or Left, 1940–1943 (New York: Harcourt Brace and World, 1968), 265.
  18. Bob Woodward, Maestro: Greenspan’s Fed and the American Boom (New York: Simon & Schuster, 2000), 163.
  19. Alan Greenspan, “Testimony Before the Subcommittee on Domestic and International Monetary Policy of the Committee on Banking and Financial Services House of Representatives,” March 5, 1997,
  20. Alan Greenspan, “Statement Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, February 26, 1997,” Federal Reserve Bulletin 83, no. 4 (April 1997): 254.
  21. Alan Greenspan, “The Interaction of Education and Economic Change: Address to the 81st Annual Meeting of the American Council on Education,” Washington, D.C., February 16, 1999,
  22. Governor Edward W. Kelley Jr., “Federal Open Market Committee Meeting Transcripts,” August 22, 1995,
  23. Paul A. Samuelson, “Summing Up On Business Cycles: Opening Address,” in Jeffrey C. Fuhrer and Scott Schuh, eds., Beyond Shocks: What Causes Business Cycles, Federal Reserve Bank of Boston Conference Series 42 (Boston: Federal Reserve Bank of Boston, 1998),, 36.
  24. United States Department of Labor, Bureau of Labor Statistics, “Major Work Stoppages in 2007,” February 13, 2008,
  25. Derek D. Rucker and Adam D. Galinsky, “Desire to Acquire: Powerlessness and Compensatory Consumption,” Journal of Consumer Research 35, no. 2 (August 2008): 257.
2012, Volume 63, Issue 11 (April)
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