Greenspan’s Market Put is Powell’s Inequality Short

By Karen Petrou

On Friday, March 22, the Federal Reserve finally conceded that aggregates and averages mask all-important economic facts, issuing for the first time the “Distributional Financial Accounts of the United States” (DFA).  This will be a quarterly staff assessment of U.S. wealth equality – or, as its data forcefully demonstrate, the lack thereof.  However, the DFA does something more:  it also tracks wealth inequality across the business-cycle over almost three decades, showing clearly that equity-price increases exacerbate wealth inequality.  As a result, the more the Fed strengthens the stock market by keeping rates low and its portfolio huge, the worse U.S. wealth inequality grows. 

With worse inequality also comes greater financial-crisis risk.  Placating markets as the Fed did yet again in January protects the Fed from short-term volatility at the cost of long-term catastrophe – too high a price for any new normalization that does not take inequality fully into account.

What the Fed Found

The DFA is an awesome undertaking in which Fed staff combine the quarterly Financial Accounts of the United States and the triennial Survey of Consumer Finances.  Doing this poses an array of methodological challenges which make numerous modifications, corrections, and assumptions critical to the DFA’s conclusions.  As with most wealth analyses, data problems increase as one ascends to the tippy-top of the one percent.  Any survey no matter if conducted for the Fed is unlikely to capture high-wealth households due to the difficulty of penetrating privacy barriers and reluctance to answer questions about vast holdings which may or may not be on the books.  Significant data variances also affect less exalted factors, with consumer debt a particularly problematic – but important – concern.  For example, Fed staff dismiss some methodological challenges – e.g., missing overdraft and payday loan data – on grounds that outstandings are small percentages of the total; they are, of course, big debts for lower-income people and thus raise another challenge to how thoroughly distributional the new DFA may be.

That said, most work – our own included – relies on only one of these two indicators.  Merging them in an attempt to capture unobserved distributions is instructive and then some.  Breaking the U.S. into the top 1%, the next 9%, the next 40%, and finally the lowest 50%, the DFA finds that:

  • The U.S. has gotten far less equitable in terms of wealth since 1989. Further, a lot more wealth is concentrated in the top 1%.  In 1989, the 1% had 23% of wealth; at year-end 2018, it was 32%, or a 39 % increase.  At the end of last year, this bottom 50 percent’s wealth share was a “barely visible” line in the relevant figure.  It’s not news that the U.S. is a lot more unequal, but it’s important that the most complete mapping to date of what households own and owe comports with different inequality methodologies.  Confirming our prior analyses and some others, the DFA also finds that the top one and ten percent gains here come largely at the expense of what we once liked to call the middle class.  This is largely due to significant valuation increases in concentrated holdings of corporate and non-corporate equity.  Durable goods and even homes do far less for wealth, making the Fed’s market-stabilization policy a boon for the investor class.
  • The DFA methodology permits better tracking of wealth data in comparison to business and credit cycles than the longer-term and often slow data provided by the World Inequality Database and other sources. Bringing data through 2018, the DFA shows a sudden halt in the inexorable inequality trend in the fourth quarter of 2019 – i.e., when the markets dove and the Fed got spooked.  As the Fed exercised its put and markets recovered in the first quarter of 2019, the DFA’s cycle predictor anticipates renewed inequality. 

The analysis says nothing further about what this means beyond detailing the interaction of equity prices with its various inequality measures and market trends.  What all these data show, though, is that the Fed has struck a Faustian bargain:  keeping interest rates low and maintaining a huge portfolio that stokes equity markets and exacerbates inequality.  This may keep a bit of seeming recovery going a little longer, but only at the cost of still more inequality which makes the risk of a financial crisis even greater.  In short, nothing may be as procyclical as the Fed’s own policies.

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