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US Federal Reserve Bank economists going Marxist on us – Bill Mitchell – Modern Monetary Theory

It only took about 6 decades or so. And, in between, there has been denial, fiction, and diversions. But here we are 2022 and work that was explicit in the 1960s is now being recognised by the central bank of the largest economy. In fact, the foundations of this new acceptance goes back to the C19th and was developed by you know who – K. Marx. Then a socialist in the 1940s wrote a path breaking article further building the foundations. And then a group of Marxist economists brought the ideas together as a coherent theory of inflation early 1970s as a counter to the growing Monetarist fiction that inflationary pressures were ultimately the product of irresponsible government policy designed to reduce unemployment below some ‘natural rate’. I am referring here to a Finance and Economics Discussion Series (FEDS) working paper – Who Killed the Phillips Curve? A Murder Mystery – published on May 20, 2022 by the Board of Governors of the US Federal Reserve System. I suppose it is progress but along the way – over those 6 decades – there have been a lot of casualties of the fiction central banks created in denial of these findings.

The topic is of course close to my heart given that I have specialised in the Phillips curve since early in my academic career.

My PhD concentrated on the evolution of the concept in the face of innovations like hysteresis, the rise in underemployment, and the impact of employment buffer stocks on the inflation-unemployment trade-off.

And going back to 1987, my first contribution to the literature, the framework I was using was exactly the same as the US Federal Reserve economists have now finally decided is the way forward if they want to understand inflationary processes.

In other words, their contribution is just repeating what some progressive (Marxist) economists have been writing about for decades.

But that just means that things are changing for sure.

Once central banks start writing about things then we are entering the realms of orthodoxy.

You might recall the Bank of England in 2015 rejected a key plank of mainstream monetary theory in a 2015 working paper, which was subsequently updated as Staff Working Paper No. 761 (published October 26, 2018 and updated further in June 2019) – Banks are not intermediaries of loanable funds – facts, theory and evidence.

Even last week, when I was presenting a talk to the Economic Society of Australia on MMT and inflation, I noted questions in the Zoom Chat questioning why I bothered to mention loanable funds and the money multiplier as if those concepts had disappeared from mainstream economics teaching programs.

Unfortunately they haven’t – yet a reading of the Bank of England research alone should mean no economist would give those ideas the time of day.

I analysed the Bank of England paper and what it meant in this blog post – Bank of England finally catches on – mainstream monetary theory is erroneous (June 1, 2015).

Anyway, last week the US FEDS publications put out the Phillips Curve paper (cited above).

The authors state at the outset:

1. “the Phillips curve failed to predict the stable inflation seen in the aftermath of the Global Financial Crisis (GFC) during 2008-2009 period, dubbed the ‘missing deflation’ puzzle.”

In fact, the Phillips curve worked well once it was properly specified.

In 2004, I examined how the changing labour market – the shift away from unemployment to increased underemployment – impacted on the inflation generating process.

First, the standard Phillips curve model predicts that the official unemployment rate (a proxy for excess demand) impacts negatively on wage inflation.

I found that the unemployment rate in a typical Phillips curve model still exerted a statistically-significant negative influence on the rate of inflation.

Second, when I added an underemployment variable I found it exerts negative influence on annual inflation with the negative impact of the unemployment rate being reduced.

Third, I also found that movements in short-term unemployment are more important for disciplining inflation than unemployment overall. This result was consistent with the hysteresis model which suggests that state dependence is positively related to unemployment duration and at some point the long-term unemployed cease to exert any threat to those currently employed.

This suggests that a downturn, which increases short-term unemployment sharply, reduces inflation because the inflow into short-term unemployment is comprised of those currently employed and active in wage bargaining processes. In a prolonged downturn, average duration of unemployment rises and the pressure exerted on the wage setting system by unemployment overall falls.

This requires higher levels of short-term unemployment being created to reach low inflation targets with the consequence of increasing proportions of long-term unemployment being created. In addition, as real GDP growth moderates and falls, underemployment also increases placing further constraint on price inflation.

I updated that work in 2008 in this paper – Labour underutilisation and the Phillips Curve – which then fed into our 2008 book – Full Employment abandoned.

What that research told me was that the Phillips curve was alive and well, but the labour market proxy for excess demand had to be broadened to include the rise of the gig economy and underemployment.

As motivation for their work, the US Federal Reserve authors cite one of their own from 2017 in saying:

The substantive point is that we do not, at present, have a theory of inflation dynamics that works sufficiently well to be of use for the business of real-time monetary policy-making.

In other words, relying on the mainstream approaches – the NAIRU concepts – which came out of the Monetarist takeover of macroeconomics in the late 1960s – have resulted in the ‘experts’ not having a clue about the phenomena they wax lyrical over and, more importantly, make policy about, which impacts negatively on millions of workers and their families.

To say they do not have a theory of inflation dynamics – that is, a statement of their ignorance – is not a statement that there is no theory of inflation dynamics that more or less captures the evolution of the data.

Effectively, that is what their paper is about – revealing the existence of a workable theory of inflation.

The problem for them is that those who work within a Marxian-Progressive tradition have known about this theory and used it for decades.

And it has been the prejudice and Groupthink of the mainstream that has prevented them from seeing that.

And like all instances where Groupthink dominates, the ‘clinical’ practice that is based on the dominance theoretical stance is typically very damaging to those that are impacted.

Remember this quote from Franco Modigliani, one of the co-authors of the original NAIRU terminology.

In 2000, reflecting on what central bankers had done in his name, he said.

Unemployment is primarily due to lack of aggregate demand. This is mainly the outcome of erroneous macroeconomic policies… [the decisions of Central Banks] … inspired by an obsessive fear of inflation, … coupled with a benign neglect for unemployment … have resulted in systematically over tight monetary policy decisions, apparently based on an objectionable use of the so-called NAIRU approach. The contractive effects of these policies have been reinforced by common, very tight fiscal policies (emphasis in original

We considered Modigliani’s about face in detail in my 2008 book with Joan Muysken – Full Employment abandoned.

Anyway, back to the US Federal Reserve economists who want to tell their readers they are on track to articulate what really caused the “the demise of the Phillips curve” (as in their model of the Phillips curve derived from Milton Friedman’s Monetarism).

In a way, I am happy that these characters think they are coming up with some new understandings even though they are just reinventing the wheel.

The important point is that they are now mainstreaming our work even if they don’t care to admit or even know that.

Essentially they spend 36 pages developing a conflict theory of inflation model, which they think has gained validity because of “structural changes in the labor market since the 1980s”.

But it is only the specification of the ‘model’ that has changed not the underlying causal structure.

That structure is rooted in the conflictual relations of Capitalism and the battle between workers and capital for real income share.

They fight that battle via their claims for nominal shares of national income and use their price setting power – workers bargaining for higher nominal wages and bosses pushing for higher nominal profit margins.

Inflation emerges and persists as these ‘price setters’ engage in what has been called the ‘battle of the markups’.

I discussed the idea in this blog post among many others – Distributional conflict and inflation – Britain in the early 1970s

The reference to the work of Pat Devine and the series of articles in the journal – Marxism Today – in 1974 is important because that work laid out the class conflict nature of inflation dynamics as a counter to the Monetarist fiction that was becoming dominant.

It is ironic that the US Federal Reserve is now just rehearsing theoretical approaches that were publicised by the Communist Party of Great Britain in the early 1970s.

That is the part I find amusing.

A rejection of the New Keynesian approach

An important aspect of the US Federal Reserve paper is that it effectively rejects the mainstream New Keynesian approach.

The authors write:

In stark contrast to the standard New Keynesian result, we find that non-monetary factors are an important determinant of inflation dynamics. Instead, we show that the process that governs inflation dynamics is intimately related to the distribution of bargaining power between workers and firms.

In other words, inflation is about real economy dynamics rather than central banks ‘printing’ too much money or expectations driving cost pressures.

A rejection of the Volcker myth

They also challenge the claim that the “disinflation since the 1980s was due to Volcker’s monetary policy”, which is part of the mainstream justification for elevating monetary policy to be the primary counter stabilisation macroeconomic policy tool and pushing fiscal policy off to a passive, subjugated role.

They show that it was changes in “bargaining power, and the resulting flattening of the Phillips curve” which reduced “inflation volatility by 87 per cent without any changes in the moentary policy regime”.

In other words, it was not what Volcker did but rather:

… structural changes in the labor market, led to reduced worker bargaining power, and it was those forces which induced the large disinflation. In addition, the consequences of the disinflation may not have been shared equally across economic agents, as workers bore the brunt of economic consequences of the decline in their bargaining power.

And this helps to understand why wages growth is so low

This is a point I have been making for some 20 years.

The US Federal Reserve authors write:

From our theoretical point of view, the lack of inflation pressure in the current situation reflects the lack of bargaining power of workers despite the extremely low rate of unemployment.

But they don’t go further – as we did in that paper I cited above – to explain why the bargaining power of workers has declined such that unions can no longer prosecute higher wage claims.

One must consider the rise of the gig economy, the increased casualisation, the rise of underemployment and multiple-job holdings and all the rest of the dimensions that come under the general heading of the ‘precariat’ – as being important aspect of the shift in inflation dynamics.

None of this really has anything to do with the rise of inflation targetting as the dominant monetary policy strategy.

It has everything to do with the shift in power away from workers to capital as a result of the rise in neoliberal governments, shifting their focus from mediating the class conflict to becoming agents of capital.

That has been a dominant characteristic of the last several decades and it has spawned legislative and regulative changes thhat have tilted the field towards capital.

And while official unemployment is typically lower than it was in the 1970s, underemployment and other forms of labour market slack (labour hire companies, independent contractors, outsourced consultancies, zero hour contracts, mini jobs, etc) have risen to maintain the discipline on wages pressure.

And this helps to explain why inflation is transient at present

And all this research is additional evidence to support my view that the current inflationary pressures are transient, which, I stress for the thousandth time doesn’t mean they are necessarily short-lived.

The point is that the dynamics the US Federal Reserve authors are referring to are what I call the propagating structures that can respond to an additional inflationary impulse and turn it into a persistent, structural force.

In the 1970s, the price setting powers of workers and firms were such that the inflation that began with the OPEC oil price rises became a self-fulfilling wage-price spiral as the two conflictual forces – labour and capital – fought it out for who would take the real income loss arising from the imported oil price rises.

As the Federal Reserve authors note – that battle ended when the bargaining power of workers fell.

In 2022, there is no wages pressure as the workers have been divided and conquered – unions are weakened, casualisation etc – and so there are just real income losses for workers arising from the cost pressures due to the supply disruptions and the anti-competitive behaviour of OPEC, not to mention the invasion of the Ukraine.

That means that once these supply and other forces dissipate, the inflation will drop away because there will be nothing propelling it further.


The US Federal Reserve paper is important because it signifies an acceptance of the class conflict framework and a recognition that class is important in a capitalist society.

For all those who think Left and Right, Labour and Capital, are meaningless dichotomies, I suggest you read the paper.

For others – you are entitled to say – we knew it all along!

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.



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