Still Economic Waters Hide Lurking Danger

By Karen Shaw Petrou

On Tuesday, FRB Chairman Powell delivered a strongly-positive statement on the state of the U.S. economy.  Citing factors such as recent wage growth and employment, Mr. Powell is far more worried about keeping the good times going than about how inequitably the good times deliver the goodies across the gaping U.S. income and wealth divide.  This is setting monetary and regulatory policy the same way a diver looking only at a calm, blue surface jumps into a lake and breaks his neck. 

As I laid out in a talk today to the Federal Reserve Bank of New York, it’s no surprise that trillions in Fed portfolio purchases and astonishingly ultra-low interest rates have done so little to boost U.S. GDP, labor participation, and wage growth and yet have done so much for the stock market.  Looking below Mr. Powell’s smooth-surfaced economy, I see sharp, jagged rocks to effective monetary-policy transmission.

The talk’s key points are:

  • Monetary-policy transmission blockages and heightened economic inequality are intertwined with post-crisis regulatory policy into a negative feedback loop that frustrates growth and exacerbates income and wealth distributional disparity.
  • Wider income and wealth inequality is not the Fed’s fault, but post-crisis policy has inadvertently made it worse. Correcting this is well within the Fed’s mandate. 
  • Action steps should add financial stability to the Fed’s objectives and ensure that inequality-increasing impacts are identified and, wherever possible, corrected. The Fed should also reduce reliance on representative-agent models and aggregate data as well as add key equality indicators (e.g., a “living-return” interest rate, portfolio-valuation impact, financial inclusion) to financial-policy cost-benefit analyses.   
  • The Fed can be a force for positive good without taking an undue role in private markets. Its formidable analytical firepower can and should identify new ways to help private capital achieve public purpose.  For example, legislation will shortly be introduced to encourage institutional investment in early-stage biomedical cures and treatments for blindness.  Developing financial-instrument models to facilitate this goal while also ensuring taxpayer protection is a challenge for which the Federal Reserve is ideally suited.

A lot of data are mustered to make these points, but a look at the charts at the end of the presentation makes all too clear how large an impact the Fed has had on economic inequality.  Inadvertent and unintended though this has been, it’s profound.  It takes no new law to reduce these unintended effects – just a look below high-level data to all the income and wealth inequality data shows the role financial policy plays in making this pernicious problem even worse than it has to be.


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