Inequality Should Matter for Central Banks

Central bankers have long been discreet about the links between monetary policy and inequality. They justify this reserve by the fact that their mandates do not charge them with addressing inequality and they generally argue that by providing price stability, central banks maintain the existing purchasing power of a currency and do not interfere with income and wealth distribution. They also often claim that inequality is not the result of central banks’ actions and that dealing with it is entirely the job of other parts of the government.

But this dogma is about to change under new constraints and for the benefit of central banks themselves. Taking inequality concerns seriously can strengthen central banks’ independence and improve their policy decisions.

Inequality: An unintended consequence of unconventional monetary policies?

The first breach of the old mainstream dogma comes from the unintended distributive consequences of unconventional monetary policies, such as quantitative easing. Unconventional policies, as implemented by many central banks after the 2008 crisis, tend to boost asset prices more than conventional policies do. And since asset distribution is skewed in favour of the more well-off households, such policies can potentially widen wealth inequality.

In the last few months, both the European Central Bank and the Bank of England, respectively, have argued that unconventional monetary policy may indeed have a material impact on inequality but that it also has a positive effect on low income households by boosting employment, which in turn outweighs its negative implications via asset price increases.

Whether unconventional policies have reduced, or at least dampened, inequality is still debated. Some academics derive the opposite conclusion about the impact of quantitative easing on inequality.[1] This heated controversy shows that central banks are not immune to concerns about inequality.

Inequality can challenge central banks’ independence

The new environment that central banks have faced since the financial crisis has forced them to rely on unconventional actions and to endorse new roles. Financial stability is now both an implicit and an explicit mandate for them. But, like unconventional monetary policies, macroprudential rules put in place to foster financial stability can affect households unequally. For example, relaxing or tightening access to mortgages through caps on debt-to-value ratios affects the distribution of household wealth in a country.[2] Similarly, lender-of-last resort actions could implicitly subsidize some households and not others.[3] Other policies chosen by central banks trigger similar concerns about inequality. External adjustment (through the exchange rate policy) as well as capital account liberalization reforms, if done too fast, may also cause an increase in inequality.[4]

All these examples show that most central banks’ policies potentially interfere with equality. Their impacts might be negligible or offsetting each other, but we cannot a priori rule out at least some unintended distributive consequences. If central banks overlook the consequences of their actions on equality, they might trigger discontent and increase public pressure for reforms. The broadening of central banks’ mandates is undeniable and one challenge ahead for central bankers is to protect central banks from populism, given the concerns that might arise from this extended mandate.

Neglecting inequality makes monetary policy less effective

Even if central bank independence is not challenged by public concerns about inequality, central banks should care about their distributive effects to increase monetary policy efficiency. Inequality matters for the transmission of monetary policy to the economy. For example: marginal propensities to consume, which determine household responses to a change in interest rates, varies with income.[5] Household access to banks or financial markets which is typically limited for low- income households defines who will be directly and indirectly affected by changes in interest rates, and thus who will react more strongly to monetary policy impulses.[6] More generally, household response to changes in monetary conditions depends on each household’s income and indebtedness profile; that is, on their disposable income profile.[7] All these variables indicate that two different income distributions can potentially induce many different impacts on the economy for the same monetary policy.

Having a solid grasp of the ways that monetary policy decisions, income and wealth distribution, and aggregate economy intertwine is thus crucial to the efficient design and implementation of monetary policy. When they assess the impact of different monetary policies, central banks should not forget to estimate the magnitude of the inequality transmission channel through which, in addition to other channels, monetary policy influences the economy. Furthermore, if central banks want to stimulate aggregate demand with the smallest impulse to avoid potential unintended consequences associated with large monetary policy shocks, then they should try to reach the people who will react most strongly to changes in disposable income.

So what can central banks do about inequality?

First, central banks should systematically report on how inequality affects the efficiency of their policies, and on how their policies affect inequality. A relatively simple way to start would be to use the banking-sector statistics – available to most central banks – and, for example, to publish the distribution of deposits and credits by income groups.

Second, in their deliberations, central bankers should identify winners and losers of their policies and make sure the costs and benefits of their choices are not too unequally distributed. A policy that benefits only a few without displaying undeniable aggregate welfare improvement should be considered with caution by decision makers.

Third, central bankers should take inequality into account when they design, calibrate and compare their policies. Different income and wealth structures modify the transmission channels of monetary policy, and an optimal monetary policy must reflect that.

Transparency about the effects of monetary policy on inequality, inclusion of inequality concerns in policy decisions and implementation of more efficient policies (by incorporating information on income and wealth structures) are three dimensions that can only have positive outcomes for central bankers. Such practices would foster public trust in central banks and reduce the risk of having their independence challenged. They would also help implement more efficient monetary policies and reduce the risk of the unintended consequences that inequality might trigger.

With price stability and financial stability central banks provide a central public good. Solving inequality is certainly not the primary job of central banks, but it is a factor that they should not ignore. Securing balanced growth and a fair distribution of the benefits and costs of price stability and financial stability is a public good, too.

The opinions expressed herein do not necessarily represent the position of the National Bank of Romania.


[1] Montecino and Epstein (2015) find that the Fed’s quantitative easing has increased inequality in the United States. Mumtaz and Theophilopoulou (2016) and Saiki and Frost (2014) reach the same conclusion for the United Kingdom and Japan, respectively. Stiglitz (2015) argues that that the way monetary policy has been conducted so far has asymmetric effects on inequality: workers lose more in downturns than they make up in recoveries. His claim is supported by Furceri, Loungani and Zdzienicka (2016), who empirically highlight the asymmetric effect of monetary policy.

[2] Carpantier, Olivera and Van Kerm (2016) show that the level of wealth inequality depends, among other factors, on the level of caps on loan-to-value ratio. They find that the impact of relaxing or tightening them is a priori uncertain and must be assessed empirically.

[3] Mitkov (2016), for example, shows that bank bail-out policies are susceptible to benefitting high-wealth households more than others.

[4] Furceri and Loungani (2015) find that, on average, capital account liberalization reforms increase inequality and reduce the labor share of income in the short and medium term.

[5] Auclert (2016) shows that differences in marginal propensities to consume is an important channel through which interest rates impact aggregate demand, and thus, that different income distributions imply different responses to a monetary policy shock. Kaplan, Moll and Violante (2016) show that differences in marginal propensities to consume weaken the direct (intertemporal consumption substitution) transmission channel of monetary policy, which makes its efficiency contingent on its impact on the economy through the indirect (labour income increase) channel.

[6] Areosa and Areosa (2016) show that limited access to financial markets coupled with income inequality changes optimal monetary policy rules and introduces inequality stabilization concerns for central banks that seek to optimize welfare.

[7] Voinea, Lovin and Cojocaru (2017, work in progress) show that the transmission of monetary policy is more efficient for middle income households, which are more indebted and have adjustable rates, as lower policy rates increase the disposable income of these households.