Central Banking and Inequality – Taking Off the Blinders

Since the financial crisis, the relative importance of monetary policy in the toolbox of macroeconomic policies has increased. In parallel, we have seen a renewed social and political concern with rising inequalities in income and wealth. However, the two trends are rarely connected.[1] Despite studies that suggest that the post-crisis unconventional monetary policies tend to exacerbate inequalities, the standard line of central banks is that these “unintended consequences” fall outside their mandate.

From a broader, social perspective, this position is unsatisfactory in several ways. In a recently published paper (the final version of the article is on the publisher’s website, the authors’ pre-proofs version is here), we explain why by confronting the discourse of the representatives of three major central banks[2] – the Bank of England (BoE), the European Central Bank (ECB), and the U.S. Federal Reserve (Fed) – with an evaluation of monetary policy from a broader, ethical perspective. This juxtaposition, divided into three questions discussed in more detail below, shows that today’s monetary policy operates under a narrow set of blinders when it comes to dealing with inequalities. We propose one way in which this situation could be remedied, and how inequalities could thus be factored into monetary policy.

Why care about inequalities and how?

From a normative point of view, central banks might care about inequalities for intrinsic reasons – containing inequalities has value in and of itself – or for instrumental reasons, because inequalities have a negative impact on their current objectives. In the second case, inequality would fall squarely within the mandate of central banks. Representatives of the BoE and the Fed hint at such effects, whereas the ECB is more sceptical about them. The central banks analysed differ even more markedly in their stance on the question whether containing inequalities is important for intrinsic, rather than for merely instrumental, reasons. The BoE is by far the most progressive, explicitly acknowledging the importance of equality. The Fed adopts a “sufficientarian” stance, that is, a position underlining the importance of everyone reaching a minimum standard of living; this is manifest in the Fed’s emphasis on the importance of fighting poverty and unemployment. Representatives of the ECB, meanwhile, do not say anything that would suggest a commitment to containing inequalities for its own sake.

Two intermediate conclusions can be drawn here. First, the BoE apart, the reasons for which central banks care about inequalities remain rather limited. Second, to the extent that central banks acknowledge intrinsic reasons for containing inequalities, this raises the further question of how to arbitrate trade-offs between this and other social objectives, such as price stability or financial stability. None of the central banks we have surveyed take this logical next step. Given their mandate, we cannot blame them for not doing so, but this does not render their discussion of inequalities any more satisfactory.

What is the causal impact of monetary policy on inequalities, and can it be justified?

While it is trivially true that any monetary policy has a distributional impact, the consensus is that before 2007 this impact was not systematic. Central bankers recognise that the crisis has changed things. Across the board, they acknowledge that quantitative easing and other post-crisis policies have had a significant impact on inequality – see, in particular, the pioneering paper from the Bank of England.

According to the doctrine of double effect, three conditions need to be fulfilled to justify such undesirable side-effects: they need to be unintentional, the value of the intended effects has to outweigh the disvalue of the unintended effects, and there must not be any other means available to obtain the desired effects without, or with fewer, undesirable side-effects.

Central banks argue along these lines to justify their policies: they claim that the inegalitarian side-effects are unintended, that their policies were necessary to save the financial system, and that these policies will be temporary. However, we find three reasons why these justifications do not stand up to scrutiny.

First, there is nothing in the central bank discourse at the start of the crisis that suggests awareness of the problematic impact of their policies on inequalities. This suggests that they did not consider less inegalitarian alternatives. They can therefore hardly claim with hindsight that there were none available.

Second, even if central banks were not able to be sensitive to inequality concerns in 2008 because the stability of the financial system was at stake, this does not absolve them of the duty to work towards a scenario where they can show such sensitivity in the years following the 2008 crisis. Arguably, central banks could, and should, have done more – either themselves or through indirect advocacy – in the aftermath of the crisis to reduce the risk of future financial crises and thus avoid situations in which they are forced to enact policies with inegalitarian side-effects.

Third, many observers now question the temporary character of the new unconventional monetary policies. As the example of Japan powerfully illustrates, the unwinding of QE is not a straightforward exercise. Yet, if the large balance sheets of central banks are the new normal, this undermines the justificatory claim that unconventional monetary policy measures are exceptional and temporary.

Is it both desirable and feasible to ask central banks to contain inequalities?

Suppose you accept that containing inequalities is important for its own sake, and that monetary policy exacerbates inequalities. Does this yield a conclusive argument for a change in current monetary policy and, if so, should it be reflected in a modification of central banks’ mandate?

We distinguish three ways in which central banks might show sensitivity to inequalities. First, the mandates of several central banks, including the ECB, already contain tie-breaker rules that require the bank to choose the less inegalitarian policy, other things being equal. However, we think that these tie-breakers rules are too weak. Second, at the other extreme, one might incorporate a permanent objective of fighting inequalities into the mandate of central banks. We have serious reservations concerning this radical proposal because the political nature of this objective is clearly incompatible with the current independence of central banks. The third option, which we endorse, is to ask central banks to factor in the distributive consequences of their policies only when they envisage the adoption of extraordinary policy instruments.

The discourse of central bankers reveals two kinds of objections to this last proposal. First, they argue that they do not have the adequate policy tools to address inequality. Given the innovative policies that central banks have adopted since 2008, this argument comes as a surprise. Why not be as innovative when it comes to inequalities? Whether it is the idea of a quantitative easing focused on infrastructure bonds or the much-discussed proposal of helicopter money, feasible and less inegalitarian policy alternatives do exist.[3] What is lacking is the political will to seriously consider or adopt them.

Second, one of the most common arguments of central bankers is to assert that it is the task of governments, not central banks, to take care of the distributive effects of monetary policy. This argument is weak for two reasons. First, under conditions of capital mobility, redistributive taxation has become a lot harder to implement in recent decades. Therefore, when the fiscal hands of the state are tied, monetary policy should be more sensitive to the inequalities it creates than otherwise. Second, and more fundamentally, since redistribution always entails efficiency losses, public policy – including monetary policy – should strive to prevent inequalities from occurring in the first place rather than having to mop them up through tax-and-transfer policies after the fact.

In sum, it is both desirable and feasible to make monetary policy sensitive to distributive concerns.


[1] A lucidly argued exception is William White’s blog on this website.

[2] For reasons of space, we cannot reproduce any of these statements here, but we have inserted links to a sample of representative statements. For more details, please refer to the paper itself.

[3] Since the end of our period of analysis in January 2015, central banks have admittedly discussed helicopter money more frequently, but this has yet to yield any concrete results in terms of policy.