Fixing the Economy Requires Giving Power to People Who Answer to the Public

The new Biden administration has promised to repair the health of democracy and the economy. While the president pledges to reverse the erosion of democratic norms that culminated in the last, violent gasps of the Trump presidency, he has also criticized an American economy that for too long has rewarded “wealth over work.”

Repairing our democracy and rebuilding the economy go hand in hand. Democracy is not just about bowing to legitimate electoral outcomes, or civility in public life — it is also about the exercise of power in the economy. Unfortunately, the link between capitalism and democracy has been broken for more than four decades. At the root of this problem is the U.S. Federal Reserve, a government agency that stands outside of democratic politics. Forty years ago, the Fed became the most powerful institution in American economic life. Its history reveals just how much work there is to do for the new administration.

In 1981, Ronald Reagan was inaugurated president. In hindsight, Reagan’s victory seemed to usher in many economic trends that still shape American life, from the rise of Wall Street and Silicon Valley to increasing economic inequality.

But what first initiated these developments actually began months before Reagan’s inauguration: subsequent tax cuts and market deregulations. In 1979, President Jimmy Carter appointed Paul Volcker as chair of the Federal Reserve, America’s central bank.

At the time, Americans were suffering from double-digit inflation, which government had failed to tackle. Soaring inflation ate into the value of savings and wages. Many commentators, left to right, blamed the popular pressures of “democracy” — people expected too much from the economy and economic policymaking — for the crisis.

With Volcker in charge, the Fed raised interest rates to the stratosphere to stop prices from skyrocketing. But the high interest rates of the “Volcker shock” also choked off credit and enterprise, leading to a sharp recession that helped bring Reagan to office. Once there, Reagan left the Fed alone. When Volcker reduced rates in 1982, inflation had been quelled and a new economic era began.

The Volcker shock transformed patterns of capital investment. First, high interest rates compelled businesses to prioritize short-term profits over long-term investments, such as by parking cash in banks to earn profits on Volcker’s high interest rates, rather than investing in their businesses and hiring workers. This crushed manufacturing communities in the Northeast and Midwest.