First appeared in Policy Center for the New South
While the economic recovery around the world remains uneven, fragile and unbalanced across sectors, financial markets are generally doing very well, thank you! In the United States, only half of the unemployment caused by the pandemic last year has reversed, while stock markets have continued to soar. Of course, this largely reflected the extraordinary support provided by the monetary authorities since March of last year.
As in the period following the global financial crisis of 2007-2008, voices have been raised to talk about monetary policy and central banks as drivers of income and wealth inequality. Unconventional “quantitative easing” policies protect holders of financial assets and enhance their assets, while working people are going through tough times on the real side of the economy. As we have already mentioned here, the financial markets have disconnected difficulties in the street of the commons, with the help of the policies of the monetary authorities.
Does attributing an impact of income and wealth concentration to the policies of central bankers make sense? It is complicated…
The argument that central bank unconventional monetary policies worsen inequality typically begins with the remark that monetary easing works in part by raising asset prices, such as stock prices. As the rich own more assets than the poor and the middle class, “quantitative easing (QE)” policies would increase the already high wealth disparities in the countries where they were applied.
However, consider first that volatility and below-potential macroeconomic performance particularly affects the bottom of the income and wealth pyramids. The proper exercise of the stabilizing function attributed to central banks is good for those who have less capacity to defend themselves against unemployment and inflation.
To those who always ask me to save or support financial institutions in crisis situations, I always ask what the alternative scenario would be. The design of such support may still minimize the wealth rewards for owners, but the truth is that macroeconomic scenarios in cases where the financial system collapses cannot be ignored as economic recovery becomes more difficult. in such circumstances.
Mary Daily, president of the Federal Reserve Bank of San Francisco, recently observed how the long expansion of the United States economy after the global financial crisis could only have happened because of the stabilization measures that followed, with interest rates decided on the basis of a return of inflation to the target of 2% per year. Unemployment rates have fallen to levels close to historic lows. The country’s average GDP growth rate during the period was lower than in previous decades, but this was not due to monetary policy. She notes:
“This created real opportunities for large numbers of alienated Americans, many of whom were seen as permanently out of the workforce or lacking the skills needed to work in a changing job market. (…) By early 2019, employers were hiring African American and Hispanic workers at rates equal to or higher than white workers. (…) This has reduced long-standing unemployment gaps, bringing them to historically low levels.”
Moreover, according to a recent Federal Reserve Bank bulletin, the prolonged macroeconomic expansion has particularly valued assets held by those at the bottom of the wealth pyramid. (Bhutta et al, 2020). Figure 1 shows how the median family net worth in the United States continued to increase from 2013 to 2019, while the average family net worth underperformed. The median measures divide the population into two halves and are lower than the averages due to the degrees of concentration of wealth at the top. A rising median from the average therefore means that the net worth of families at the bottom of the pyramid has increased more.
Figure 1 – Evolution of the median and average net worth of families, surveys 2013-2019
Source: Bhutta et al (2020)
Some economists do not recognize the need for macroeconomic stabilization through proactive central banks and argue that loose monetary policies favor the top of the pyramid. This would be the case if the expansionary policies favored profits more than wages, in addition to the extraordinary gains of the financial intermediaries used to implement the policies. (Weiss, 2019). Empirical evidence, however, points to the predominance of income distributional effects of expansionary monetary policies (Colbion et al, 2014). Across business cycles, the effects of monetary policy generally do not have much net effect on aggregate inequality (Bernanke, 2015).
If, on the one hand, it does not seem appropriate to say that the stabilization policies of central banks increase inequality, on the other hand, it is increasingly accepted that income and wealth inequalities affect the efficiency of their policies. As recently noted by Luiz Awazu Pereira da Silva, Deputy Director General of the Bank for International Settlements (BIS, 2021):
“…inequality reduces the effectiveness of monetary policy transmission. (…) . A high concentration of income can indeed affect the transmission of monetary policy through the various effects that accommodating monetary conditions have on heterogeneous households. Wealthier households have a much lower propensity to consume; therefore, their consumption may be less responsive to monetary stimulus. In turn, poorer households may not benefit from easier credit terms because they lack collateral or adequate credit ratings and are therefore unable to borrow.
The heterogeneity of the effects of monetary policy on heterogeneous household conditions is illustrated in Chart 2, taken from a speech by Philip R. Lane, Member of the Executive Board of the ECB. It shows how the overall effect on consumer spending through various transmission channels of a 100 basis point drop in euro area interest rates varies with household wealth. Like Way (2019) Explain :
“First, the classical and intertemporal substitution channel is only present for households without financial constraints who are able to save. It represents only about a third of the total impact on overall consumption. Second, the cash flow channel is particularly strong for homeowners with limited financial assets, who tend to take out large mortgages, often at adjustable rates. Third, spending is strongly driven by the revenue channel. This channel is heavily skewed towards low-income households, which also tend to benefit disproportionately from a more buoyant labor market. Fourth, the strongest effect on asset prices occurs through increases in house prices. This effect turns out to be quite large for highly indebted homeowners, as their consumption is more sensitive to house prices.”
Chart 2 – Effects of a 100 basis point drop in interest rates on consumption in the euro zone, by household wealth
Notes: The chart shows a breakdown of the effects of a 100 basis point cut in interest rates on consumption. The total consists of four parts. The standard intertemporal substitution effect (IES), the cash flow effect, the income effect and the housing wealth effect. The magnitude of these effects varies by household wealth. The Eurozone in this chart refers to France, Germany, Italy and Spain.
Source: Way (2019).
The consumption expenditures of the low-income cohort and the cohort of homeowners with only limited financial assets increase more intensely following a 100 basis point drop in interest rates, increasing by almost 1 .0% and 1.6% respectively, while the consumption of the financially free group increased by only 0.4%. The bottom line is that the effects of monetary policy decisions depend on the pattern of income and wealth distributions.
The increase in income and wealth inequality over recent history in many countries has fundamental structural reasons, such as technological changes and the impacts of globalization, in addition to the absence of effective social protection networks and national traits regarding racial prejudice, ethnicity, gender and social class in access to education, jobs and sources of income. Fiscal and public expenditure policies can do a lot. Financial regulators can also help through actions and regulations that democratize access to and availability of low-cost financial resources, minimizing market concentration.
In principle, it would be the job of monetary policy to avoid unemployment and inflation, as in inflation targeting regimes adopted by independent central banks. It should be noted, on the other hand, that recent developments in central bank policies, going beyond the control of short-term interest rates and the prevention of illiquidity of longer-term assets, tend to blur the boundaries between monetary and fiscal policies, due to the selectivity on the assets to be favored.
In this context, there are even proposals for coordination between fiscal and monetary policies to define fiscal programs to be supported through monetization by the central bank. (Bartsch et alii, 2019). There is also the proposal by Christine Lagarde, President of the European Central Bank, to give special treatment to “green bonds” in their asset acquisition programs, making “quantitative easing (QE)” a “quantitative greening”. Like the climate agenda, budget programs dealing with inequalities could well end up falling into the arena of central banks!
Otaviano Canuto, based in Washington, DC, is a Principal Investigator at Policy Center for the New South, a non-resident principal investigator at Brookings Institution, an associate assistant professor at SIPA – Columbia University, lecturer in international affairs at the Elliott School of International Affairs – George Washington University, and principal of the Center for Macroeconomics and Development. He is a former vice president and former executive director of the World Bank, former executive director of the International Monetary Fund and former vice president of the Inter-American Development Bank. He is also a former Deputy Minister of International Affairs at the Brazilian Ministry of Finance and a former Professor of Economics at the University of São Paulo and the University of Campinas, Brazil.