At the most basic level, inflation is a rise in the prices of things. Specifically, it’s a rise in the general price level, not the rise in a specific price. You might imagine that one day there’s a big Zoomer, hipster revival of interest in the band Pavement, and then the cost of Pavement LPs goes through the roof. That would be a rise in prices, not a rise in inflation. Inflation would be like seeing a rise in prices of a general basket of goods, ranging from the gas you put in the car to the food you buy at the supermarket and the steel that a manufacturer buys as an input into other manufactured products.

What causes it? The classic textbook definition that you’ll find in an Econ 101 class is that inflation is a case of too much money chasing not enough goods. You can think about money as a claim on real goods and services — you get it and it entitles you to claim these real things with use-values that are produced in the economy. But if you were to issue too much money without adequately expanding the stuff there is to buy with it in the economy, you would see a rise in prices, because people would be bidding against each other for a limited stock of goods with more and more money.

Like a lot of textbook economics, this leaves a lot of basic questions unanswered: What’s determining the money supply? What’s determining the stock of goods and services? What is determining the pricing policies that the people who sell these things are using to decide what they’re going to charge for them?

In a way, the definition of too much money for not enough goods is a good starting point, but it leaves a lot that still needs to be explained. To understand those questions, you need to take a more institutional approach than you see in textbook economics. First of all, you need to look at the conditions of production of things that are being bought and sold.

A classic example is that in the 1970s, a powerful driver of inflation was the cost of oil. Oil is an input into almost everything — to get anything onto a shelf, you need to use some kind of energy — so a rise in the price of oil can lead to generalized inflation.

But what affects the price of oil? The answer to this question has to do with the political relationships between oil-producing countries, many of which are in the Global South; between the major oil companies, many of which are multinational but headquartered in the Global North; and between governments — like the Saudi government and the US government. You’ll need to understand what’s going on at oil refineries, and the position that the Oil, Chemical, and Atomic Workers International Union is taking in their collective bargaining.

To get behind a seemingly obvious thing like the rise in the price of oil, you need to look at these relationships of power between different social groups.

The best way to think about a central bank is as a bank of banks. It stands at the top of the banking system and controls some of the levers that affect the kind of lending and borrowing that other banks further downstream will do.

In the US, the central bank is the Federal Reserve. It’s only existed since the 1910s. Before that, the banking system wasn’t controlled in this way. Since the 1910s and the Progressive Era, we’ve had the Fed.

The central bank controls the general availability of money and credit throughout the economy. At all levels of the economy and at all levels of the financial system, at any given time, there will be a demand for money, credit, and liquidity to grease the wheels for all kinds of economic activity. I want to buy a house, so I borrow money to do that. I want to expand my steelmaking plant, so I get a business loan to do that. There’s a big range of possibilities and terms on which I can get access to that money and credit. The terms of access to money and credit are set or heavily influenced by the central bank.

This bank has a couple of levers for doing that. Some of the most important are setting interest rates. The Federal Reserve sets the Federal Funds Rate, which is an interest rate at which banks can borrow from each other. You can imagine how the Fed controls the access of downstream banks to money and credit, and then the banks in their business and consumer lending will pass on credit at terms influenced by the terms set by the central bank.

When you read in the newspaper that the Federal Reserve has raised rates, this is usually referring to the Federal Funds Rate. Say that they raise the Federal Funds Rate. Then, a bank that’s looking to make a mortgage loan will find itself paying more to access liquidity, so they’ll charge the richer borrower more in turn, too. Something that happens at the Federal Reserve level will then trickle down to the conditions under which people looking to buy a home will be able to do so. It will affect the kind of interest they’ll have to pay to get access to that money.

National income is a way of thinking about the value of all the goods and services that are produced in a country in a given time span. The measure of national income that we use is Gross Domestic Product (GDP). If the national income is the value of everything that’s produced in the economy, one way to think about the national income is as the value of all the goods and services produced in the economy. But you can also look at it as the sum of incomes that are paid out in the economy, because for every good and service that is produced, someone is getting an income of some kind, whether that is wages, profits, or rents.

The sale of an item represents the value of the good or service produced. But if you look at it from the other side, this value is also an income that’s going to someone. You can think about GDP not just as a set of goods and services, but also as a set of income flowing to different places.

Within that, you can break down the national income and ask, “Where is this income going?” A certain percentage is going to wages, salaries, and other kinds of compensation to people for their labor. The ratio of compensation to labor over the total national income is the wage share. This is the chunk of the value of what’s produced that is being paid out to workers for their labor.

The ratio of total value to the value the workers are receiving is an index of how much workers are able to get out of the system. From a Marxian approach, this would be a measure of the rate of exploitation: How much of the social product is going to the people who make it, and how much of that surplus is being taken by someone who is not the direct producer?

If you look at the wage share over time, you can get a sense of how strong labor is, because you get a sense of how much of the value of what they produce they’re able to claim back in the form of compensation.

You wouldn’t want to look at the wage share as the only index of this strength, especially over the short term, because all kinds of things can affect it. But over the long term, it’s a fairly good measure, and it shows a sharp decline in labor’s share of income.

What role has the wage share played in inflation? A lot of conventional economic models, including the models that the Federal Reserve has used to decide on monetary policy, view the labor share as a driver of inflation. These models assume that holding all other things equal, if the labor share of income increases, inflationary pressures will increase, and the Federal Reserve will want to tighten monetary policy or raise interest rates in order to limit the growth of money and credit in the economy.

The important upshot here is that in order to slow economic activity, the Federal Reserve will react to a rise in the wage share by slowing the economy down, even to the point of inducing a recession.

The reason that they see this connection is that they think that a rise in the wage share implies a squeeze on the profit share of income. The flipside of an increase in what workers get is a decrease in the profits enjoyed by businesses.

They further assume in their model that businesses will respond to falling profits by trying to raise prices, because they want to keep their margin of profit — they’re not happy to see it fall because workers are being paid more. They will try to raise prices, and where those price increases are effective, prices throughout the economy will go up. It’s a chain of events that leads from workers’ successful claim to more of the income that the economy produces to a reduction in profits by the businesses that employ them, to increases in prices, which can become self-sustaining, and to an inflationary dynamic that is a central banker’s worst nightmare.

Earlier moments Federal Reserve policy looked not only to freeze the income distribution, but to change it in a regressive fashion. It’s not just that the Federal Reserve in the eighties and nineties was afraid to let the wage share increase; it was actually undertaking such aggressive, tight monetary policy that the wage share decreased.

The Fed is now okay with a constant wage share, which means that there won’t be a progressive redistribution. It’s also a halt to the regressive redistribution that Federal Reserve policy drove for a long time. But there are sharp limits to what this truce covers.

The Federal Reserve, including Powell, doesn’t think that wages should never increase. Their recent statements show that they welcome some wage growth, which has occurred recently. The problem is that they think this wage growth should be constrained very tightly by a specific set of parameters: the rate of inflation and the rate of productivity growth. They think that wage increases are okay as long as they are kept within those parameters.

What do those parameters mean to us? The first one is the rate of inflation. If the money wages that you receive, measured in dollars, are staying the same while inflation is going up, your real wages are falling. There’s the same number on your paycheck, but what you can buy with it is going down.

The second piece is productivity growth. It’s okay for real wages to rise, as long as they don’t rise faster than the growth of productivity. The basic principle is the premise underlying the post-1945 golden age of capitalism, in which economic growth became a substitute for redistribution. It is the idea that a growing pie would allow for everyone to have more income in an absolute sense, even though the distribution of that pie didn’t change.

The idea that wage increases should be tied to the increase of productivity is a version of this idea — that it’s okay for workers to get more if the whole economy is growing, and their wage increases are proportional to that growth of the economy. That’s a way for workers’ real wages to rise without the share of profits in the economy changing at all.

Powell is okay with wages increasing, but within the bounds of this classical golden-age idea of the politics of productivity. Powell has backed away from some of the harshest politics of neoliberalism from the late 1970s through 2020, in order to return to something like the 1945–1973 model, in which productivity increases led to increases in real wages, but had to be kept within those bounds.

No one has an exact picture of what’s going on yet.

Most of the inflation we’ve seen so far is not the result of a generalized wage push. One of the other ways that the Federal Reserve has changed is its acknowledgement of this. As late as 2016, it thought about the labor market as a fundamental source of inflationary pressures in the economy.

But the statements made by Powell, Treasury Secretary Janet Yellen, and the Biden Council of Economic Advisors show that they now have a different way of thinking about the labor market. They think about sector-specific problems, like a bottleneck in the production of semiconductors leading to an increase in the price of new cars, which then leads to an increase in the price of used cars. They tend to center that much more.

Now the general consensus now seems to be that we do not see a generalized increase in wages across the economy, and that, in fact, wages are rising more slowly than inflation at the moment. We’re very far off from the point of increasing real wages, much less creating a wage increase that would take away from profits.

With that said, there is also evidence that in certain industries that have seen some of the most powerful and rapid expansion with the end of the shutdowns — hospitality, entertainment, outside-of-the-house dining industries — there have been increases in labor costs, which may be showing up in prices, although it’s too soon to say that conclusively. Importantly, the fact that wages are not rising across the economy does not mean that this isn’t happening in some sectors. It’s fairly clear that it is happening somewhere.

The US economy started to see inflationary pressures from late 1965 onward. Those initial pressures were tied to the Vietnam War mobilization, which happened quickly and without a lot of time or political will for adjustments in the economy, other than inflation.

Prices increased slowly around the mid-’60s, but by 1979, when the Volcker Shock occurred, annual rates of inflation reached double digits — over 10 percent. By world standards, this inflation was not dramatic. Inflation in other countries can occur by hundreds or thousands of percentage points.

But for the United States, especially outside of wartime, double-digit inflation was relatively high. It alarmed a number of observers from across political parties and the class spectrum. There was a generalized sense of a crisis. It wasn’t a completely manufactured crisis. Everyone agreed that something had to be done about this inflation.

In the late 1970s, pressures mounted because of a few specific events. One was that, starting in 1978, there was a lot of pressure on the US dollar in international currency markets. Currency traders moved to bet against the future value of the dollar, given the strength of US inflation and their skepticism that the problem could be dealt with politically.

That dollar crisis was the immediate reason that Volcker was appointed to the Federal Reserve. Coverage of his appointment featured headlines like “The Dollar Chooses a Chairman.” People thought that pressure from the global currency markets made it important to bring inflation under control, because inflation was seen as a cause of the international skepticism of the dollar’s stability.

The Iranian Revolution also took place in 1979. It had direct effects on oil production, but also fed a general set of expectations that there would be disruption in the price of oil. Because oil is one of the most important inputs to everything in the American economy, this meant instability in oil markets and an increase in the price of oil, which would lead to dislocations across the whole economy.

Volcker came in against a background of more than a decade of inflation, with these other events raising the sense of urgency. The question was what he, or anyone else in the government, was going to do about the inflation. People had been trying to deal with it since 1966, with little success.

Volcker’s breakthrough was a revival of the old-fashioned way of dealing with inflation. In the late nineteenth century, inflation wasn’t much of a problem. Whenever it seemed likely, the workings of the international gold standard led to a deflationary response. The possibilities of economic stimulus were limited by the requirement that monetary expansion be tied to gold reserves.

There were no problems with inflation in the late nineteenth century because it was easy — almost automatic — for this system to respond to any pressure on labor markets or other markets with an increase in unemployment.

The late nineteenth century was a mirror image of the late twentieth century, with frequent crises, depressions, and business failures. At that point, there was no central bank to sort through things. But there was no problem with too much worker power, and no problem with inflation.

By the 1970s, macroeconomic management had come a long way, meaning that the deep depressions of the late nineteenth century no longer took place. But there was the new problem of inflation. Volcker went back to the late nineteenth century playbook, and he said that the solution to inflation was unemployment. Not just a little bit of unemployment, but extreme, politically painful unemployment.

The Volcker policies led to the highest unemployment in the US since the 1930s. Volcker willing to go into a near–Great Depression level of unemployment for the first time in thirty years. At that point, it seemed like the only option left for dealing with inflation.

In some ways, the Volcker Shock was less of a departure than it seems. Federal Reserve policy throughout the 1950s and much of the 1970s shows a surprising willingness to put up with unemployment. But there were often fairly high levels of unemployment in the 1950s, to the extent that when John F. Kennedy became president in 1961, there was over 7 percent unemployment. A big theme in Kennedy’s inaugural address was the slack in the economy. Volcker-like policies were present at earlier moments in Fed history, even during the period we think of as a time of consensus and economic good times.

Volcker’s singularity is exaggerated in a way that understates how comfortable US policymakers have always been with serious unemployment. The idea that the United States ever enjoyed decades of full employment is false. But 1979 was still a turning point.

The Volcker Shock took place in late 1979, and about a year later, Ronald Reagan was elected president. The shock came at a time when the presidency also turned towards what we now call neoliberalism, a policy of wage repression and anti-labor policies.

In the 1960s, John F. Kennedy or Lyndon Johnson would have pushed back against Federal Reserve rate increases because they saw relatively full employment as an important part of maintaining their political futures. A Democratic president had to be able to deliver something to workers and unions. This resulted in fighting between the Federal Reserve and the presidency. But Reagan, despite some disagreement within his administration and moments of tension with the Fed, supported Volcker’s policy of a recession as the medicine for anti-inflation, and even welcomed it.

Reagan wanted to break the labor movement in the US. This was famously embodied in his breaking of the air traffic controllers’ strike, where he not only broke the strike, but also imprisoned the leaders of the union and permanently replaced the strikers. This is universally acknowledged as the starting gun a corporate private-sector campaign against unions.

Reagan and his advisors thought that unemployment was a great complement to this strategy. A union bargaining in the middle of a depression will ask for a lot less than one bargaining in the middle of a tight labor market. That went both ways. Volcker was very clear that he saw Reagan’s intervention in the air traffic controllers’ strike as the most important support that the administration gave to his fight against inflation.

Not at all. It was an obsession.

One of the big lessons I’ve drawn from reading transcripts of Federal Reserve discussions is that while monetary policy sometimes seems abstract and technical, if you actually read about how the central bankers themselves thought about things, it’s a very concrete and almost simple story of class struggle. They were not confused or uncertain on that point.

Volcker was obsessed with unions. Transcripts from this time show that he monitored the latest news out of Detroit, the latest news out of steel, for signs of progress in their anti-inflation program. Volcker intervened in this process not just through monetary policy. In 1979, Chrysler was near bankruptcy and required a government bailout. Volcker was involved in the bailout, which involved restructuring the union’s agreements with Chrysler. In that process, Volcker had the specific goal of breaking with the patterns of collective bargaining in auto that had prevailed for the past thirty years.

This is something people still argue about today: What were the causes of the 1970s inflation? Can they be understood? Some economic historians try to say it’s 30 percent due to rising oil prices and 10 percent due to this, that, or the other. No one has come to a definitive answer. The important point, though, is that according to Volcker, workers were to blame.

From Volcker’s perspective, the real cause of inflation was an oil shock linked to geopolitical events in the Middle East, but then the oil shock by itself was just the beginning of the process. Say that the oil shock sets off inflation. Then there’s the question: Will workers be able to defend their real wages against inflation, or will they pay the cost of inflation?

Inflation starts somewhere else in the system. Let’s say that workers didn’t cause it at all. There’s still a question of whether the inflation will lead to workers’ real wages falling, or whether they’ll be strong enough to fight to protect their wages. Volcker was willing to entertain the idea that there might be a variety of causes of inflation. But he thought that the fact that workers were strong enough to protect their real wages was a problem, and that it would translate an oil shock into an economy-wide inflationary spiral. Even if he might admit that there were other causes of inflation, he thought that a crucial link in the chain — workers’ ability to defend their real wages — needed to be broken.

Absolutely, and that’s very clear from his testimony before Congress. He said that the oil shock was basically external; the costs would be borne by the US economy somehow. He was not willing to think that these costs would come out of profits, partly because he thought that profits had already been squeezed a lot through the ’70s and the system couldn’t afford to see them squeezed any further.

Volcker comes off as a villainous figure in this story. There’s good reason for that, but it’s also important to think about the way historical actors understood what they were doing. I think that Volcker sincerely believed there was no alternative to what he was doing. He believed that if you didn’t crush inflation through an induced recession, there would still, at some point, be a recession later.

He was an old-school guy — a pre-Keynesian — in his thinking. He thought that if the good times were too good, you would have to pay the price one way or another. In his own mindset, he wasn’t causing gratuitous pain; he was hastening an adjustment which would have had to happen anyway. It’s important to mention this so that we don’t make these people out to be comic-book villains who took pleasure in what they did.

We cannot think of Volcker as a corrupt figure who went to Washington to line the pockets of himself and his friends. But he spent his whole life in a socially specific environment: first, the Chase Bank, which was headed by Rockefeller and was by the 1970s the largest bank in the world, with significant foreign lending, and also the New York Branch of the Federal Reserve.

The New York Fed is really important, and not just because New York is a big city or because Wall Street is there. The New York Federal Reserve is also the appointed liaison with international capital markets.

Between his public service at the New York Fed and his professional background at a big international bank, Volcker brought with him a set of assumptions about what the system required to work, which he would not have seen in the terms of special pleading or narrow particularism. His thinking was more like this: If profits fall too far, or if the international value of the dollar falls too far, that will lead to a generalized economic problem in the United States, which will eventually hurt everyone, even if the people it hurts first and most are places like the Chase Bank.

A common way to think about ideology is as a way of harmonizing a particular interest —say, David Rockefeller’s interest in the strength of the dollar as the reserve currency — and a universal interest. For someone like Volcker, those interests would have been more or less similar. When he intervened to bail out international lenders, which he did in a big way during the early 1980s, he saw it as a way to prevent the collapse of the entire economic system, not as a way to help his former employer.

Hegemony works partly by taking certain possibilities off the table. The best way to think about alternatives is to go back to the simple model of the wage price spiral. The way that the Fed thinks about things is that if wages go up, profits will go down, and businesses will raise prices in order to protect their profit margins.

If you think about that as a technical description of an economic process, you might ask: Why does the intervention have to be to control wages, rather than to control pricing decisions? You might say that rising wages in the steel industry should be reflected in falling profits for steelmakers, and that the government should try to enforce that by limiting the degree to which steel prices can increase.

To some people, it sounds like that could never happen in the United States, and that our traditions of free markets and anti-state sentiment would make that impossible. But I think that’s wrong.

Absolutely! In 1962, John F. Kennedy called the head of US Steel into his office and yelled at him until he rolled back a steel price increase. It wasn’t a crazy idea. The idea that things like steel or electrical goods — the commanding heights of the economy — were so central to the economy that their pricing policy was actually a legitimate object of government intervention was not at all foreign at the time.

The World War II economy was almost a totally planned economy. There were also direct controls during the Korean War. Someone in Washington decided on allocations —essentially how many cars Detroit was going to get to build the next year. The same thing happened in the early 1970s, when Nixon imposed the wage and price controls that are sometimes referred to as the nation’s first peacetime wage and price controls.

That’s a little bit euphemistic when you consider the ongoing US role in Southeast Asia at the time. But it shows that as close to 1979 as 1974, there were wage and price controls. Opinion polling from the time shows that the general public was open to this, as were some of the technocrats of the Carter administration.

Barry Bosworth, Jimmy Carter’s inflation czar at the time of Volcker’s appointment, actually resigned from government because he thought there should be mandatory controls, and the administration wasn’t willing to go for it. As crazy as it sounds to us now after decades of neoliberalism, the idea that there might be some other way — a more direct kind of control that might fight inflation — was not at all foreign at the time.

The clearest line connecting those conditions to the viability of these policies is a deep crisis of the capitalist system in the 1970s. By the late 1970s, there was widespread concern that profits were not high enough.

The concentrated industrial core of the US economy that defined US economic power around 1950 was under deep threat by the 1970s. The threat started in industries like textiles, which are low on the value chain. But by the 1970s, it went up through electronics, aircraft, and other high-end things that had been the last preserves of US economic dominance.

But contemporary observers are also keen to link the profit squeeze to excessive wages. That’s more debatable empirically, but there was certainly a felt need on the part of business. By the late 1970s, these various causes of crisis had led business to organize in a big way.

Those familiar with books like Kim Phillips-Fein’s Invisible Hands or some of Rick Perlstein’s histories will know that the seventies saw a big mobilization of business, unified to an extent it had almost never been unified before, trying to push against consumer protections, against regulations of all kinds, against labor unions, and in some cases for a kind of import protection.

That mobilization by business, which by 1979 had become very powerful, was a big obstacle to a more centrally-planned or direct-control approach to the problem of inflation.

Why was finance, as personified by people like David Rockefeller and Paul Volcker, in the lead? First, financiers and asset owners are historically often among the biggest group of people opposing inflation or worrying about inflation. That’s because inflation tends to erode the value of existing wealth and assets and particularly debt.

If I’m a bank and I lend money in 1970, and then there’s a lot of inflation over the next decade, by 1980, the real value of the debt I’m owed is eroded. Inflation is good for debtors and bad for creditors.

But there are other reasons too. By the late 1970s, a huge percentage of profits for the US financial sector came from international activities. The financial sector had responded to falling profitability in the US domestic economy by increasing its activities in countries around the world, including countries in the Third World. They discovered that this was where there was still room for rapid growth.

It was also, in the 1970s, a time when many of these nations received an economic stimulus from rising commodity prices. A classic example is that US banks were hugely invested in Mexico, which benefited from the high oil prices of the 1970s. For these international bankers with an increasing share of their profits coming from abroad, it was important to keep the dollar as the world’s reserve currency.

It was called a recycling process, where these immense superprofits coming from the petro countries went through the US financial system and then back out again. The reason that happened was that the currency of the oil market was the dollar, so these things were already naturally dollarized, and that, more generally, the dollar had become a kind of de facto world money after World War II.

The US international banking community, as it was sometimes called, had a big interest in making sure that the dollar continued to play this role. But that required that the dollar remain a stable source of value. The banking community thought that inflation at home would undermine the value of the dollar, therefore leading to countries starting to use other currencies instead of the dollar to hold their reserves and to use as the unit of international banking.

This concern was heightened in the late 1970s by the formation of the European Monetary System, which is an ancestor of the Euro. There were rumors that Saudi Arabia would start to hold reserves in Deutsche marks or in yen, instead of in dollars. There is a financial equivalent to the manufacturing competition story we’ve talked about. It was an open question whether the dollar would remain the unchallenged world money.

That’s a specific reason, beyond the general reason that bankers don’t like inflation, why people like Rockefeller and Volcker felt the situation to be very urgent in the late ’70s.

In some ways, the effects were most serious abroad. In the United States, unemployment touched 10 percent. It caused a lot of human suffering, especially in certain places like Youngstown, Ohio and Pittsburgh, Pennsylvania. But this was not as bad as what happened in the Global South.

The reason why the Volcker Shock was a global problem is that in the 1970s, there had been a huge spree of lending to Third World countries by bankers from the Global North. During the seventies, many Third World countries had become increasingly indebted. In particular, they were indebted to US banks, which meant that their debts were dollar debts, and they’d have to pay these debts back in dollars. The Volcker Shock raised the cost of dollarized debt. It caused a huge increase in interest rates for anyone who owed dollars.

For Third World countries with huge amounts of debt, this created a problem where meeting the interest payments on these debts became impossible, let alone paying it back. That led to a cascade of sovereign debt crises. Mexico is the famous example, but it happened all over. This created an opening for an early version of the Structural Adjustment Programs, which become very common in the 1990s, in the age of the Washington consensus.

The Volcker Shock made these debts so hard to pay back that these countries needed a bailout, and the people giving the bailout were able to demand a lot in exchange. One of the things they demanded was an end to these countries’ national industrial development programs.