By Karen Petrou
- An influential new Fed staff study asserts that increased market power is to blame for much of U.S. income inequality over the past forty years, discounting monetary policy’s impact after 2008 by looking only at inflation, not also at QE and ultra-low rates.
- Incorporating these factors into its construct and reviewing other research suggests a large causal role also for post-crisis monetary policy.
- Which is worse is yet to be told, but it seems clear that market concentration, monetary policy-fueled asset-valuation hikes, and ultra-low rates exacerbate the structural factors on which the Fed continues to blame economic inequality. Indeed, concentration and post-crisis policy are likely to be considerably more causal than the prolonged decline in educational quality, demographic shifts, increased innovation, and perhaps even regressive fiscal policy.
Subscribers know that the focus of this blog is the ill-recognized, but potent, force of post-crisis financial policy on U.S. income and wealth inequality. Much of the research we’ve analyzed since 2017 provides strong quantitative and qualitative support for our hypotheses. Now, a new Fed staff study takes direct issue with this research, pinning the inequality blame instead on market concentration over which financial policy plays only a limited, indirect role. Given the reputation of these authors and their formidable analytics, we were ready to post correctively. However, we conclude that a considerably more holistic and updated analysis is required to absolve post-2008 monetary policy. When one is undertaken, we think market power will rear its head, but be far from alone.
What the Study Says
In addition to making a strong case that redistributional tax policy would be good for the financial system, the paper tackles a wide array of data from 1980 to 2008 and (less often) all the way to 2018. It then runs these data through a complex series of models to test the impact of market power on U.S. income inequality. Using often traditional assumptions, the paper concludes that the rise of corporate market power in both product and labor markets is the cause of declining labor-income share, rising profit share, increasing income inequality, towering household leverage, and resulting financial instability. Focusing only on the U.S., the paper is part of growing literature critiquing current antitrust and tax policy, adding the inequality element found in one cross-national study and little other work outside the direct sphere of labor economics.
Before turning to its monetary-policy conclusions, it’s worth noting some caveats to the paper’s powerful conclusions. Because the paper is models-based and the models depend on the author’s assumptions and chosen variables, we observe that:
- “Spirit of capitalism” assumptions drive model expectations about the interaction between income inequality and credit accumulation, with higher-income households believed to invest in financial assets to achieve the lifestyle of the rich and famous. This lifestyle motivating force is said to drive greater reliance on capital, not labor income. However, it could also be that wealthy people have the investments from which to derive capital income and have no need to labor in the vineyards. Or, it could be that the dearth of higher-yielding assets outside financial markets plays a critical role powering large companies that do not invest in tangible production, or the productivity-inducing innovation that might otherwise support more equitable labor income and greater equality. The link between post-2009 quantitative easing and financial-market asset valuations has been studied in our blog since 2018 and is more than subtly evident in COVID market conditions. Failing to consider inequality and market realities and instead building models on behavioral assumptions may lead to problematic conclusions.
- We also question the “spirit of capitalism” assumption on which household debt is modeled. Here, the paper assumes that households take on debt to “keep up with the Joneses.” This may well have been true for 1970s suburbia. But, we doubt its bearing in recent years when low-, moderate-, and middle-income household debt burdens have soared for non-status expenses such as medical services, student debt, and the rising cost of basic necessities. A heterogeneous understanding of household debt would alter the link between household leverage and financial crises posited in this paper by incorporating wealth inequality into the financial-instability measurement and likely also altering causality.
- The paper’s preferred approach to modeling financial stability assumes that the amount of debt has no bearing on borrowers’ decisions to default and thus increase the odds of financial instability. This is because, the models assume borrowers maximize their own “efficiency.” However, we believe that most retail borrowers are forced into default when time runs out and they cannot pay their bill; few have the discretion to pick their moment. Large borrowers may well measure the impact of payment versus non-payment by what they can get away with in accordance with the paper’s efficiency model – maybe – but this is far less true of most households.
To be sure, the paper measures its models against empirical evidence over the course of the years from 1980 to 2016. As a result, these models may well be informative about the profound impact of market power and is resulting social-welfare concerns. It is where the paper discounts monetary policy where we think models meet reality in a head-on collision.
Monetary Policy and Income Inequality
The analysis in this paper and its models focus only on inflation and the extent to which monetary policy affects it. This is debatable on three counts: first, the paper studies only disinflation in the 1980s and 1990s, thus providing little insight into current monetary policy. Second, the Fed has formally acknowledged that its policy doesn’t affect inflation in the manner assumed in this paper. Finally, even if it did, more inflation is arguably good for lower-income households who thrive in hot employment markets where wage growth exceeds the rate of inflation. It’s not inflation that boosts inequality; it’s the toxic combination of QE-fueled financial-asset wealth, and the scorching impact ultra-low rates have on wealth accumulation for all but those who already have some.
Over the last decade, inflation has of course been essentially flat, yet income and wealth inequality have skyrocketed in concert with market power, household indebtedness, and the financial-stability risk evident in March of 2020 that cannot be attributed solely to COVID’s powerful macroeconomic shock. One could say that there has been disinflation since 2008 due to low rates or – at least as valid – one could say that low-, moderate-, and middle-income families have seen considerable price inflation in the goods and services that matter to them – see for example a Cleveland Fed study to this effect.
More to the inequality point, QE has had demonstrably distortionary impact on financial-asset valuations that in turn drive wealth inequality, and ultra-low rates have made it impossible for households to amass even precautionary savings that buffer solvency against income shocks. The inability of Americans also to accumulate wealth for long-term financial stability is demonstrably due to persistently low interest rates in a nation such as the U.S. that generally lacks defined-benefit plans and the ones we have are going broke due to ultralow rates. Market power may well not help given its ability to keep wages low in sectors with more labor supply than demand, but this alone cannot account for the sharp increases in financial valuations since the Fed put its foot on the accelerator, nor does it explain the fact that a penny saved is no longer a penny earned.