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Inflation and the City

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from the magazine

Inflation and the City

New York will have to grapple with exploding prices, both economically and fiscally. Spring 2022
New York
Economy, finance, and budgets

After a 40-year break from high inflation, Americans are rediscovering what it means when the prices of goods and services rise rapidly. With 8.3 percent inflation in April, people now must spend $108.30 to buy the same food, clothing, day care, electronics, and other day-to-day needs that cost $100 a year ago. Inflation doesn’t just affect household spending, moreover. If it continues, which seems likely, it will have a severe impact on New York City’s economy and budget, as Wall Street profits suffer, public-sector workers demand double-digit raises, and the cost of construction projects soars, among other consequences. City government can’t entirely avoid this national shock. But smart leadership from Gotham’s new mayor, Eric Adams, can blunt it.

Two things cause inflation, and both are with us today, as they were in the 1970s, the last time America saw sustained high inflation. The first is supply shock: that is, something happens abruptly to cut off the supply of a good that people use regularly and that they can’t easily substitute with another, cheaper good. In the 1970s, the supply shocks were two oil crises: the Arab oil embargo of 1973 and 1974, related to the Yom Kippur War; and in 1979, the Iran hostage crisis, which similarly sent oil prices into orbit. Today, the supply shock is largely due to pandemic-related disruptions around the world, which have kept people from manufacturing and shipping goods. Russia’s invasion of Ukraine and the curtailment of Ukraine’s critical grain exports, as well as sanctions on Russia’s oil and gas exports, will intensify the effect.

The second big factor is the money supply—the amount of ready money in the American economy available to spend or invest but not including sums already invested in assets such as stocks or houses. The United States, like most Western countries, runs on fiat money—that is, money not backed by gold or another store of physical value. Instead, the government, through the Federal Reserve, literally creates money, largely through setting interest rates at which banks can borrow. When rates are low, the money supply expands; when rates are high, the money supply shrinks. The Fed has a natural bias toward low interest rates and increases in the money supply, in order to keep up with the American public’s desire to borrow.

But the Fed generally cuts interest rates more sharply, and thus more dramatically expands the money supply, when it fears recession—as it does when the economy suffers supply shocks. In the 1960s, the money supply doubled. But in the 1970s, as the Fed confronted shock after shock, the money supply tripled, from less than $600 billion to $1.5 trillion. The money supply would not rise as quickly again until after the 2008 financial crisis, when the Fed slashed interest rates to an unprecedented low of zero and kept them there for seven years, until 2015. To revive the economy, the Fed reasoned, Americans had to borrow more—even though record household lending had helped trigger the crisis in the first place. In January 2008, the money supply was $7.5 trillion. By February 2020, the eve of the pandemic, it had doubled to $15.5 trillion, mostly because of this post-financial-crisis money creation.

Though the purpose of growing the money supply is to boost economic activity, and thus employment, the intention can backfire. More money can stimulate more economic growth only if the economy can quickly respond to this demand creation by producing more goods and services.

If this happy result doesn’t occur, inflation results: more money chasing the same amount of goods and services that existed before. In the 1970s, inflation rose from 3.3 percent annually in 1972 to 11.1 percent in 1974. It remained persistently high, often in double digits, until 1983. The 1970s were not a good decade for the U.S. economy. From 1974 to 1975, the country lost 2.9 percent of its jobs, and unemployment, having remained well below 4 percent for most of the 1960s, hit 9 percent in 1975. The Federal Reserve kept slashing interest rates, from 12.9 percent in mid-1974 to 4.6 percent in early 1977. Rather than spurring high growth, though, lower interest rates just introduced Americans to new terms: “stagflation” and “the misery index”—a persistently double-digit rate of unemployment and inflation combined.

In the early 1980s, then–Federal Reserve chairman Paul Volcker determined to break inflation’s back. To do so, he had to raise interest rates sharply, thus tightening the money supply and making it tougher for businesses and people to borrow. Rates, tremendously volatile already, blasted from 9.5 percent in mid-1980 to 19 percent by early 1981, where they stayed for six months. This sharp rise in the cost of money brought a short, but deep, recession. Even as the nation’s homebuilders and automakers protested, as potential customers couldn’t borrow, Volcker held fast. He had to prove not only that the Fed would cut inflation, whatever the public uproar, but that it would never again countenance double-digit inflation. It eventually worked: by the mid-1980s, inflation had fallen below 5 percent; by the 1990s, it was hovering close to the Fed’s annual 2 percent target. For nearly 40 years thereafter, people and firms could invest and lend with confidence, knowing that the base that those decisions stood upon—the dollar—would reasonably maintain its value.

Why didn’t inflation spike after 2008, when the Fed slashed interest rates to zero? Partly because the economy suffered no supply shocks. In fact, the U.S. economy was awash with a surplus of goods made by cheap labor abroad. Abundant cheap labor at home, via immigrants often working below the legal minimum wage, also restrained prices. The economy did experience a different type of inflation, however: asset inflation. The price of stocks, houses, and other investments reached record highs simply because people had no other place to put their cheap money. In the aftermath of the pandemic, the Fed reduced rates, once again, to zero.

“New York City fared worse than the rest of the country during the 1970s stagflation, losing 16.1 percent of its jobs.”

Now, though, the more traditional cycle, of increases in the costs of everyday goods and services, may be starting anew. After the pandemic began in March 2020, the Fed pumped the money supply at a rate never previously seen. As of this writing, the money supply stood at $21.8 trillion, thrice as high as it was barely a decade and a half ago. The economy has never had so much money looking for a place to go.

New York City fared worse than the rest of the country during the 1970s stagflation, losing 16.1 percent of its jobs between 1969, a postwar high, and 1977. Though the nation at least grew in fits and starts between recessions during the 1970s, leaving the U.S. with more jobs at the end of the decade than at the beginning, New York would not recover its lost 1970s jobs total until 2008. Inflation wasn’t the only culprit in New York’s decline, of course: the city suffered the destabilizing results of middle-class flight to the suburbs, skyrocketing crime, and a failing transit system.

But inflation definitely made things worse. New York lost 11 percent of its financial-services jobs in the 1970s, for example. Inflation harmed banks’ profits; the business of financial services is investing and lending, after all, but both were moribund. The stock market ended the 1970s at a lower level than at the start of that lost decade; in inflation-adjusted terms, stocks plummeted. As for lending: if inflation erodes the value of the dollar as a borrower repays a loan, the lender can end up losing money.

The low-inflation era that began in the 1980s, by contrast, jump-started New York’s economy. Wall Street took off, as both stock and bond (lending) markets boomed. The city’s population rose again, as white-collar “yuppies” flocked to the city to work not just in banking but in related professional industries, such as lawyering and advertising, and as immigrants and other working-class newcomers came in search of job opportunities created by this newfound wealth. The city rebuilt its tax base, giving it the resources to reinvest in its neglected physical infrastructure and, a decade later, to help confront its violent-crime crisis.

What now for New York? Though history never quite repeats itself, the parallels between the early 1970s and today are eerie. Just as in the 1970s, New York City doesn’t seem like a great place to live right now, if you have other opportunities. The city’s unemployment rate is 8.8 percent, more than double the national rate. As of December, the city’s private sector was missing 9.8 percent of its jobs, relative to December 2019; the only reason that the unemployment rate is lower than 9.8 percent is that some people who lost their jobs left the city, searching for better chances elsewhere, and some people have given up entirely, leaving the workforce. Crime is skyrocketing, with the murder rate up more than 50 percent in two years. New York’s affluent population is falling: the number of white kindergarteners, a good, if rough, proxy for affluence, fell by 16 percent post-pandemic, far higher than among any other racial group. The city’s economy doesn’t start from a great position to withstand high inflation, to say the least.

And high inflation may worsen these trends. Finance still powers New York’s economy, and one reason the city budget has withstood the last two years of turmoil, in addition to tens of billions of dollars in federal aid, is that Wall Street has earned record profits. Yet high inflation remains bad for Wall Street, just as in the 1970s. On the stock-market side: inflation erodes consumer confidence, thus harming corporate profits. Inflation also pushes up the price of the materials and labor that companies need to produce their goods and services, further slicing profits. On the lending side: financial firms, again, will be reluctant to make loans if inflation will erode repayment dollars.

A struggling Wall Street would have an outsize effect on the city. As state comptroller Thomas DiNapoli reported last year, Wall Street jobs constitute just 5.2 percent of the city’s private-sector total—but those jobs pay nearly $407,000 on average annually, five times as high as the average $92,000 wage in the rest of the city’s private sector. Wall Street jobs thus make up one-fifth of all private-sector wages, and 14 percent of all economic activity, “more than any other industry.” A steep drop in Wall Street profits and bonuses could shave $3 billion from New York’s personal-income-tax revenues alone, taking out half the city’s $6 billion in budget reserves against its $101 billion budget.

This anticipated fall does not account for how, in a recession, Wall Street firms would look to cut costs, including real-estate costs—something made easier by how, during the pandemic, workers proved that they can do their jobs outside of expensive midtown Manhattan. Even with record profits, as the comptroller notes, Wall Street has been shrinking, down nearly 2 percent in 2020, to 179,900 jobs. “The loss of industry jobs in the city, at a time when profits are soaring, may be attributed to a combination of advances in technology and the relocation of jobs,” writes DiNapoli. “In 2021, job losses appear to have accelerated, with the industry on pace to lose 4,900 jobs.”

These New York losses come at a time when “Wall Street” jobs, in the rest of the nation, are growing, observes the comptroller; portions of the industry have moved to Florida and more hospitable climes, from a tax and cost perspective (and for other reasons, including, during 2021, relative freedom from Covid restrictions). That New York depends on Wall Street is nothing new, but a downturn would be particularly acute now, with the rest of the city’s economy so fragile. Every job loss now amounts to a greater share of the city’s shrunken economy.

Chart by Alberto Mena

Inflation could also have a direct impact on the city budget. Theoretically, inflation should not harm it directly, since, as private-sector wages rise, the tax revenues that the city collects would also rise and more residents would find themselves pushed into higher tax brackets. Yet this assumes that private-sector wages will rise in tandem with inflation and that people won’t resist paying more of that money to the government and decide to relocate to lower-tax states and cities.

Inflation would increase the cost that taxpayers shoulder to employ city workers. Despite modest reductions in the number of city employees that Mayor Adams suggested in his first budget presentation, in February 2022, the city still employs more than 334,000 people as of this spring—at an annual cost, in wages and salaries, of $30.6 billion. As it happens, the city’s major labor agreements are expiring or have already expired. The labor contract with District Council 37, the biggest civilian union, with 59,000 workers, elapsed in May 2021, and the agreement with the United Federation of Teachers, with 112,900 workers, ends this September.

As inflation spikes, unionized city workers will demand raises to keep up. The state comptroller estimates that 1 percent raises would cost about $500 million. (Raises have knock-on effects for city-paid pension contributions, as pensions are paid as a percentage of salary.) Yet city workers won’t be asking for a 1 percent raise. They’ll probably demand annual 5 percent raises and above to keep pace with rising prices—at a cost of $2.5 billion in the first year, $5 billion in the second year, and so on. Even if Wall Street profits hold up, the city would swiftly find itself drained of its $6 billion in reserves at this rate, and in deficit.

In the late 1970s and early 1980s, New York actually used inflation to its advantage in paring labor costs. Mayor Edward Koch’s administration held fast against granting inflation-adjusted raises, partly because state and federal oversight forced it to, after the city nearly went bankrupt in 1975. In 1980, city workers sought 14.5 percent raises yearly. Yet the mayor inked agreements with labor unions representing 200,000 workers for 8 percent annual raises over two years. At a time when inflation was running at 10 percent, these agreements saved the city money in inflation-adjusted terms. Importantly, the city never put clauses into contracts allowing wages to increase automatically with inflation, though the unions asked for them. “Inflation helped us,” says one former Koch budget official.

Yet this is a dangerous game. Adams can hardly award 7.5 percent raises to match inflation—nor can he award, say, 5 percent raises, hoping that inflation remains high over the term of a contract; if inflation falls, the city would wind up paying more in real terms. “Rising expenditures, including wages newly negotiated, in times when inflation is well above average could be a threat to ongoing fiscal balance if not supported on the revenue side,” says Tom Kozlik, head of municipal research and analytics at HilltopSecurities, an investment firm.

“In terms of approaching the unions,” suggests Peter Goldmark, budget director under Governor Hugh Carey in the late 1970s, when the state oversaw Gotham’s emergence from the fiscal crisis, “both the state and the city should indicate firmly and early to the unions that they are taking a broad, cooperative, and progressive approach to inflation. A central axiom of that approach should be that the more unions cooperate in limiting raises during this difficult period, the greater will be the city’s capacity to avoid layoffs.” Goldmark adds: “Despite all the references to miraculous pots of money and reserves of federal funds, the city operating budget over the next couple of years is going to be severely pressed, and if raises are not kept to reasonable levels, then there may have to be a serious number of layoffs.” If government workers hold out for inflation-linked raises, the city should simply allow agreements to remain expired for a few years. It’s easier to assess inflation costs in the past than in the future.

Next, consider the cost of the city’s debt. The good news: New York City is far better off here than in the 1970s, when it didn’t balance its budget and borrowed billions yearly just to make ends meet. The money had to be refinanced every year, at the new, prevailing interest rate. The rate went up as inflation rose, as lenders wanted to ensure that they were compensated for the eroded value of the dollar and because the city’s credit was getting riskier. In 1973, New York paid a 5 percent interest rate on its bonds; by 1975, just before the city’s default, the rate had nearly doubled.

Today, the city owes $94.2 billion. In contrast with five decades ago, this debt wasn’t incurred to meet day-to-day expenses but to improve New York’s physical infrastructure, such as roads, bridges, and school buildings. Further, most of this debt, $86 billion, like a long-term home mortgage, has a fixed rate of interest. Even if inflation rises, and lenders want a higher interest rate to compensate, they’re out of luck. Perversely, if inflation mounts, the city can repay this debt with ever-cheaper dollars. “Sustained inflation theoretically would help existing debt become relatively more affordable,” says Kozlik.

The flip side of this supposed advantage, though, is that New York needs to borrow more money. Over the next five years, the Adams administration wants to invest $100 billion in capital, including perhaps more than $9 billion to build jails in four boroughs in order to close Rikers Island. Most of this money, $95.4 billion, would be “city-funded”—that is, borrowed. Even with record-low interest rates, the city expects its annual debt-service costs—payments on principal and interest—to go from $6.8 billion to $9.6 billion over the next four years. Abruptly higher interest rates levied by lenders to compensate for runaway inflation would make such new borrowing prohibitive, undoing some of the benefit of repaying older debt with cheaper dollars.

Then, too, there’s the infrastructure that the city proposes to build with all that borrowed money. Though national inflation stands at 7.9 percent, inflation in the construction industry is running nearly twice as high, at 13 percent. New York cannot build its new jails anywhere close to budget with this double-digit inflation, nor can it even ensure that bridges remain in good condition. The high inflation of the 1970s produced such an infrastructure backlog that, a decade later, the Williamsburg Bridge almost collapsed, causing Koch to close it in the late 1980s for emergency refurbishment. The city’s public-housing stock already faces a $40 billion repair backlog—which, every year that inflation remains at 13 percent, grows by close to $5 billion.

Though the city doesn’t control the Metropolitan Transportation Authority, which runs subways and buses, its residents and commuters suffer from inflation pressure there, too. The contract for the Transport Workers Union, which staffs subways and buses, expires in 2023. The raises that the city awards to its own workers will help set the pattern for TWU workers. The MTA can’t award double-digit raises to its employees without hiking fares by an equivalent amount. But can subway and bus riders withstand, say, a 20 percent fare hike? Ridership remains at barely half of what it was pre-pandemic, with current riders mostly lower-wage retail, health-care, and other service-sector workers, already strapped by higher costs of food, child care, and other essentials.

New York City mayor Eric Adams should impress on Democrats in Washington the importance of controlling inflation. (Chip Somodevilla/Getty Images)

The city’s regulated housing sector also stands to suffer. Of the more than 2.1 million rental-housing units in the city, two-thirds of New York’s housing stock, roughly half, or 966,000, are rent-regulated—that is, a city board, under state law, sets the maximum rent increase each year. Of course, the board can’t control how much property owners’ costs go up. Last year, the city’s rent guidelines board approved a rent bump of just 1.5 percent for people signing one-year leases and allowed that increase to take place only during the final six months of the lease. This hike falls far behind inflation and comes as landlords struggle to collect back rent from hundreds of thousands of tenants who stopped paying rent due to the public-health emergency.

If future rent increases fail to keep up with cost inflation, more of the city’s rent-regulated housing stock will fall into distress or abandonment, as landlords fail to maintain properties that don’t pay for themselves. In 1990, after two decades of abandonment, 13.9 percent of the city’s rent-regulated housing units were distressed. The figure fell to a low of 4.9 percent in 2016, but it has inched up since. In 2019, the figure was 5.5 percent.

New York City is not an island—and it can’t entirely insulate itself from the damaging effects of rampant inflation. For now, Adams should impress upon fellow Democrats in Washington, including in the White House, that the government must get inflation down before it reaches double digits.

Beyond this prevention, which is the best cure, the city must ready itself to hold fast against union demands for raises that keep up with uncertain inflation. Adams also must ensure that New York spends every scarce dollar for infrastructure wisely; the specter of inflation eating away at New York’s finite dollars for infrastructure is yet another opportunity to rethink the costly four-borough jails project, for instance.

“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man,” said Ronald Reagan in 1978. Today’s New York already has too many muggers and robbers; now it must contend with the violence of inflation, too.

Top Photo: Costs for construction, a bedrock of New York’s blue-collar economy, are soaring—stymieing critical infrastructure work. (MTA/Alamy Stock Photo)

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