How Inequality Stymies Monetary Policy and What to Do About It

By Karen Petrou

  • In a dangerous double-whammy, monetary policy not only makes America even less economically equal, but economic inequality also frustrates monetary-policy transmission.
  • Thus, recessions are deeper and longer, reversing the good-times income gains central banks take as proof that their policies are not dis-equalizing even as the wealth divide grows ever wider.
  • Because monetary policy when rightly judged in terms of both income and wealth adversely affects economic equality and inequality stymies monetary policy, we won’t have macroeconomic-effective monetary policy until we have equality-focused monetary policy.

In my forthcoming book, I argue that post-2010 monetary policy has had a direct and adverse impact on U.S. economic equality, positing also an array of actions to reduce inequality and thereby hasten economic growth.  Central banks counter that monetary policy is good for equality because it hikes employment, a point Chairman Powell emphasized yet again earlier this month.  This position was also voiced by the deputy general manager of the central bank of central banks, the Bank for International Settlements (BIS).  However, this work does concede that even if monetary policy works for equality, inequality works against monetary policy.  Reason enough for change, especially once one understands that monetary policy affects wealth as well as income. 

Monetary Policy’s Problem

As in a recent summary article on this question, the BIS paper takes a global perspective, reaching aggregate conclusions about inequality across advanced nations.  This is misleading when it comes to the U.S.  For example, many studies note that low rates are effectively transmitted to lower-income homeowners because most have adjustable-rate mortgages.  True enough in the EU; wholly incorrect in the U.S, where most lower-income households have fixed-rate mortgages and for whom refis are hard to find.

Looking only at the U.S., the BIS paper absolves the Fed of an inequality impact, but shows clearly how inequality still stymies monetary policy.  For example:

  • Conventional monetary-policy thinking assumes that those who have want more – i.e., that “marginal propensity to consume” – the driving force in a consumer-driven economy such as the U.S. – comes from persuading higher-income households to spend more by making it cheaper for them to borrow.  However, wealthier households actually have a lower propensity to consume and thus respond less to monetary-policy accommodation even as poorer households do not borrow more because of obstacles to sound credit availability.
  • Given that the wealthy do not spend and the poor cannot borrow, more inequality leads to steeper drops in household consumption, especially during recessions when monetary policy tries to fight back by boosting consumption and, thereby, capital investment followed by employment.  One study of U.S. states shows that, during the 2007-09 crisis, consumption fell by significantly larger rates in more unequal states. 
  • Rising top income shares are also associated with less credit to small businesses and thus less job creation because high-wealth households do not save via bank deposits while small firms are dependent on bank credit intermediation.
  • More inequality thus is likely to lead to deeper recessions (with this based on advanced economy data that include the U.S.).  This is likely because higher inequality leads to more cyclical employment and middle-class income – i.e., boom-bust cycles that hurt low-, moderate-, and middle-income households the most.

Thus, even if one accepts the central-bank disclaimer – i.e., monetary policy doesn’t exacerbate inequality because employment improves – and ignores the profound anti-equality wealth effect of low rates and big portfolios, the BIS’s assessment of recent data shows clearly that monetary policy is not a macroeconomic remedy unless or until it forms part of the equality solution. 

We are not the only ones to have noted this – the St. Louis Fed and IMF staff for example have outlined new monetary-policy constructs they hope will do better given profound U.S. inequality.

A Digital Solution?

Because it absolves central banks of an inequality impact, the BIS paper looks for an ex-machina solution by way of fintech.  Although its transmission-obstacle analysis only references advanced economies, the fintech response is based on examples from emerging economies such as India and Sub-Saharan Africa. 

Based on this asymmetric assessment, digital finance is said to result in significant financial-inclusion improvements and thus in many more households affected by monetary-policy stimuli.  But, measuring U.S. financial inclusion along lines comparable to the BIS paper yields not the majorities of finance-marginal households found in emerging economies, but, by the FDIC’s most recent count, only 5.4% of unbanked American households.  This small percentage of households is on the economic periphery not because of digital finance – many unbanked households cannot access it even were it still more easily available to them.  Instead, they and the rest of the 85% whose wealth is less than the top ten percent’s need monetary policy that creates an equitable financial system via increased macroeconomic growth and reasonable rates of return on valiant efforts to save for the future.     

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