For decades, decisionmakers at the Fed have carefully monitored labor relations. The attention has often resulted in contractionary monetary policy aimed at restraining ostensibly inflationary wage demands, particularly those made by major unions during collective bargaining. Such was the case with the recession of 1970–1971, which put an abrupt end to an extended period of tight labor markets that had resulted in a marked increase in the wage share. As Alfred Hayes, president of the New York Fed, told his colleagues on the Fed’s Open Market Committee (FOMC):
The outlook for major [contract] negotiations in 1970 is disturbing… some moderate rise in unemployment is a necessary condition to checking the inflationary spiral. This is another way of saying “The slowdown is what we have been trying desperately to achieve. Let’s not reverse it before it has had some results.1
In the story economists tell about the 1970s, the Fed recklessly ignored the need for monetary rigor because discipline was unpopular with politicians and voters. But in reality, hawkish views like Hayes’s guided policy throughout the decade. A glance at the data shows that aggressive rate hikes were underway throughout 1973 and continued for months during the deep mid-decade recession.
The rigor reached new heights with the ascent of Paul Volcker to Fed chair in late 1979. Volcker saw wage demands as a central cause of rising prices and hailed Reagan, with his anti-union interventions, as an exceptionally effective complement to tight money. He even carried an index card schedule of upcoming union contract negotiations in his pocket. Despite occasional tensions, the Volcker-Reagan two-step got both men what they wanted. Along with inflation, union density and strike activity plummeted. The decline was led by the goods-producing sectors, where unions were either broken or forced into concessions. And when productivity growth resumed, wages remained far behind.2
As wages fell behind productivity, a shift of income away from wages was inevitable. Was it intended? Volcker would have said that defeating inflation was necessary for any future economic progress, including wage growth. If inflation destroyed the value of the dollar, a union paycheck wouldn’t be worth the paper it was printed on. He might also point out that recessions squeeze profits as well as wages. Volcker was genuinely independent from narrowly defined special interests, as evidenced by his conflict with the finance-captured core of the Obama administration. And there have been episodes—most notably, the late 1990s—when wages have been allowed to grow. There is no reason to doubt that policymakers sincerely welcome wage growth as long as they believe it poses no threat of inflation.