Monetary Policy and Inequality – What Do Central Bankers Say?

“Benign neglect” perhaps most aptly characterizes the attitude that central bankers have traditionally displayed toward the topic of economic inequality. Indeed, monetary policy and inequality have long been regarded as having nothing more in common than just the fact that they both coexist. In the last three years, however, a few noteworthy statements have been made, that seem to suggest that central bankers are seriously rethinking their stance on the topic of inequality.[1] Last month, for example, Yves Mersch, a member of the ECB Executive Board, opened a speech on monetary policy and economic inequality with a strong assertion: “all economic policy-makers have some distributional impact as a result of the measures they introduce – yet until relatively recently, such consequences have been largely ignored in the theory and practice of monetary policy.” This article reviews selected statements by representatives of three major central banks (the U.S. Fed with Raskin, Tarullo, Bullard and Yellen, the ECB with Coeuré and Mersch and the Bank of England with Carney and Haldane) on the link between monetary policy and inequality, and then summarises their conclusions around two questions:

(1) Does monetary policy influence inequality?

(2) Should central banks look at inequality when defining monetary policy?

U.S. Federal Reserve

In the United States, in April 2013, Sarah Bloom Raskin, then Member of the Board of Governors, made three interesting points: first, she argues that inequality matters for the conduct of monetary policy because it might have a significant impact on business cycles. She contends that the length and strength of the Great Recession is partly the result of the high level of inequality. She also believes that “because of how hard these lower- and middle-income households were hit, the recession was worse and the recovery has been weaker.” Thus, according to her, a better understanding of the macroeconomic impact of inequality “may have implications for the Federal Reserve’s efforts to understand the recession and conduct policy in a way that contributes to a stronger pace of recovery.”

Second, she suggests that inequality may also affect the efficiency of monetary policy by altering monetary policy transmission channels. She considers that “households that have been through foreclosure or have underwater mortgages or are otherwise credit constrained are less able than other households to take advantage of the lower interest rates, either for homebuying or other purposes.” In her view, “these effects likely clogged some of the channels through which monetary policy traditionally works.”

Finally, she believes that the accommodative[2] monetary policy followed by the Fed is likely to be the right answer to rising inequality as “the accommodative policies of the FOMC[3] and the concerted effort [they] have made to ease conditions in the mortgage markets will help the economy continue to gain traction. And the resulting expansion in employment will likely improve income levels at the bottom of the distribution.”

A year later, Daniel Tarullo, Member of the Board of Governors, noted that inequality has increased in the last decade and that the financial crisis has not changed this trend. He then states that “monetary policy cannot be the only, or even the principal, tool in addressing these challenges. But that is not to say it is irrelevant.” In particular, monetary policy can be used to moderate cycles, especially on the labor market. He argues that “a stronger labor market can provide a modest countervailing factor to income inequality trends by leading to higher wages at the bottom rungs of the wage scale.” For him, the crucial question is to differentiate between structural and cyclical unemployment, the latter being probably in part influenced by monetary policy.

In June 2014, James Bullard, President and CEO of the Federal Reserve Bank of St. Louis, addressed the link between monetary policy and inequality very directly by asking and answering three “provocative” questions: (1) Does the Federal Reserve’s quantitative easing program exacerbate income inequality in the U.S. by putting upward pressure on equity prices? (2) Would a higher inflation target in the U.S. help or hurt the poor? (3) Does current monetary policy hurt savers? He uses a simple version of a life cycle economy to answer these questions. His conclusions are the followings: (1) “actual equity prices were well below normal by conventional valuation metrics in 2008 and 2009, and they have recently returned to more standard valuations. To [him], this suggests that quantitative easing had no medium-term implications for the U.S. income or wealth distribution – it is only as good or bad as it was before the crisis.” (2) A higher average inflation rate would hurt the poorest group of the economy because they are holding more cash than the rest of the population and thus are less protected against inflation. (3) Bullard acknowledges that low interest rates hurt savers, but he argues that, during the crisis, credit markets were not functioning properly and that the Fed’s actions helped repairing the damages of the crisis more quickly, which was beneficial for savers too.

Most recently, at a conference on economic opportunity and inequality organized by the Boston Fed in October 2014, Janet Yellen, Chair of the Board of Governors, took a slightly different look at inequality and focused on unequal economic opportunities. She identifies four sources of economic opportunity in America – resources available for children, higher education that families can afford, opportunities to build wealth through business ownership, and inheritances – but she does not make any links between these aspects and monetary policy.

European Central Bank

In the euro zone, in October 2012, Benoît Coeuré, a member of the ECB Executive Board, stated that “inequality is a cause for concern for all European institutions, since social cohesion is one of the statutory objectives of the EU.” He explains that monetary policy affects individuals in different ways, through different channels (interest rates both current and expected, credit extension, asset prices), but, according to him, “it is a daunting task to disentangle and quantify these channels empirically”. He also highlights that monetary policy can impact geographical inequalities and concludes that “more evidence has to be collected before we can produce robust stylised facts.”

Similarly, Yves Mersch, referred to above, reckoned in his recent speech that “there is no clear evidence whether standard monetary policy has a dampening or intensifying effect on economic inequality” but that “non-conventional monetary policy however, in particular large scale asset purchases, seem to widen income inequality, although this is challenging to quantify.”

Bank of England

In the UK, in May 2014, Andy Haldane, then Executive Director of Financial Stability of the Bank of England, and now its Chief Economist and Executive Director of Monetary Analysis and Statistics, noted that central banks “have an impact on inequality which is, at best, indirect, inadvertent and transient” and that they cannot durably impact inequality. At the same time, he contends, that “at least over the shorter-term, central bank policies can and probably have reshaped patterns of inequality.” For him, relative winners include debtors and relative losers are savers, but he makes a strong point in emphasizing that “the majority of people – savers and borrowers, old and young – appear to have been made better off absolutely as a result of extraordinary monetary measures.”

Haldane also adds that if, over the medium-term, monetary policy cannot influence inequality, the reverse might not be true. In particular, he points out that there is growing evidence that inequality can lead to financial instability and that lower income inequality results in faster and more durable growth, even if the channels through which this happens are still not well understood.

Only a few days later, Mark Carney, Governor of the Bank of England, gave a speech on the “growing exclusivity in capitalism”. In his view, “virtually without exception, inequality of outcomes both within and across generations has demonstrably increased.” For him, monetary and financial stability is a central pillar of a more inclusive capitalism. At the same time he believes that “while to not have acted would have been catastrophic for all, the distributional consequences of the response to the financial crisis have been significant. Extraordinary monetary stimulus – both conventional, through low short-term interest rates, and unconventional, through large scale purchases of assets – raised a range of asset prices, benefiting their owners, and lowered yields, benefiting borrowers at the expense of savers.”

Conclusion

So where do we stand with regard to our two initial questions?

1) Does monetary policy influence inequality?

Most speeches acknowledge that monetary policy probably has a short-term impact on inequality. Whether monetary policy can durably modify the level of income or wealth inequality in the long-term is, however, subject to debate.

Several Fed representatives emphasize the stimulating effect of their accommodative policy on employment, and point to the fact that this has likely mitigated the increase in inequality. ECB and BoE central bankers reckon that loose monetary policy may have increased inequality by rising asset prices. At the same time, they point out that inequality would probably have been worse if central banks did not take strong measures to counter the effect of the financial crisis.

2) Should central banks look at inequality when defining monetary policy?

Several representatives cited above underline that integrating inequality in the policy decision process might help pursuing a better monetary policy. Raskin argues that “understanding the long-run trends in income and wealth across different households is important in understanding the dynamics of the macroeconomy and thus also may be relevant for setting monetary policy to best reach our goals of maximum employment and price stability.” Haldane reckons that “there is rising evidence that inequality can have an important bearing on the objectives central banks hold dear – the stability of the financial system and growth in the economy.” Finally, both Raskin and Mersch point out that inequality might also alter the effectiveness of monetary policy transmission channels.

The rethinking and public acknowledgement of the nexus between monetary policy and inequality is to be welcomed and represents a significant, positive step towards creating policies that better reflect and proactively shape social realities. It is now up to the research community to shed more light on this link and provide well-founded answers to the pressing questions surrounding the topic of monetary policy and inequality.



[1] Alan Greenspan and Ben Bernanke are two early exceptions to this. Speaking as Federal Reserve chairmen, they both acknowledged as early as 1998 in the case of Greenspan, and as early as 2007 in the case of Bernanke, that income and wealth inequality has increased in the United States in the last three decades, but they attribute this phenomenon to factors other than monetary policy, like, e.g., skill-biased technology, international trade, immigration, or labor market institutions (like minimum wage levels or the decreasing influence of labor unions). When it comes to policy implications to reduce inequality, Bernanke does not mention monetary policy and Greenspan concludes that “our goal as central bankers should be clear: We must pursue monetary conditions in which stable prices contribute to maximizing sustainable long-run growth.”

[2] An accommodative monetary policy is designed to stimulate economic growth by lowering short term interest rates, making money less expensive to borrow, or by expanding the overall money supply.

[3] The Federal Open Market Committee (FOMC) is responsible for formulation of monetary policy in the U.S.