Reader comments on monetary policy and inequality
I posted a question to our readers…
How should monetary policy change if reducing inequality was seen as the most important priority?
An assessment of the comments…
The real issue of monetary policy’s effect on inequality its purpose to generate a “wealth effect” which will increase spending. A few things were said about the wealth effect.
Dannyb2b: “The central bank needs to be reformed. No reforms, no solution IMO. The fed just needs to be tweaked so that it interacts with different counterparties… Buying assets through OMO’s or QE is very uneven or imbalanced because it works through increasing wealth of existing asset holders and assets are concentrated. Asset holders have a lower MPC than broader public so the effect is limited… The solution I see is to create a wealth effect that affects all people by transferring new assets (money) to all when targeting inflation or growth or whatever. Average people have a higher MPC meaning less money needs to be expanded to realize changes in gdp or inflation.”
He is explaining the problem with monetary policy creating inequality. It is true that the wealth effect has helped the economy recover through increased consumption. However, consumption by capital income is at a very level while consumption by labor is very low. So consumption by the rich, which is created by the wealth effect, is being praised as a success of monetary policy. Yet, the resultant inequality is becoming a side effect greater than the original disease. (source for increasing capital consumption)
PeakTrader responded to Dannyb2b: “Monetary policy has a powerful effect on growth. You’re ignoring the history of the Fed and confusing negative economic factors outside of the Fed’s control with monetary policy… I stated before, lower interest rates and higher asset prices induce people to spend and borrow, and reduce saving, a lower cost of capital spurs production, refinancing at lower rates increases discretionary income, lower mortgage rates makes buying a home more affordable, 401(k)s and IRAs increase in value, etc. There are massive multiplier effects throughout the economy.”
Peaktrader supports current monetary policy and praises its ability to affect growth. Yet, he seems to say that the inequality generated is beyond the Fed’s control. This thought was echoed by JazzBumpa…
JazzBumpa: “Bottom line – Monetary policy is the wrong tool to do the desired job.”
The conclusion seems to be that monetary policy can create inequality but it cannot reduce it. An interesting thought, but can we accept this conclusion? It may be that monetary policy is in a trap. As inequality grows and effective demand weakens through the MPC effect Dannyb2b mentions, monetary policy has to generate an expansion through low interest rates and QE. Moreover, the expansion must lead to inflation.
Mark Sadowski: “Inequality reached its peak in the US in the Gilded Age when there was persistent deflation, and its nadir in the 1970s when there was rapid inflation. It seems to me if you want less inequality you obviously need more expansionary monetary policy.”
Mark Sadowski makes a connection between inequality and inflation/deflation. He associates deflation with inequality. We saw this in Japan in the last 20 years. During their period of deflation, labor share fell.
Bruce Webb touches upon the connection between labor share and inflation: “Stop or at least discount labor cost as being a simple contributor to core inflation… Managers will ALWAYS see labor as a cost to be controlled and bond clippers will ALWAYS see any uptick in labor costs to put the country at risk of Weimar 2. That is the consequence of seeing labor through capitals eyes as a necessary evil… I don’t know technically how you could compute an inflation index ex labor share but conceptually it seems as simple as looking for evidence (or lack thereof) that additional wage income/labor cost was actually driving up the cost of core goods.”
The question then is… Does inequality create low inflation through a sufficiently low labor share? If yes, the higher labor share of the 1970’s supported inflation, while the current low labor share is undermining inflation. Moreover, the inflation that central bankers are hoping for will not come, as long as inequality grows upon a low labor share. So maybe it is true that a perpetually low Fed rate creates inequality, which then creates low inflation, which then anchors more inequality, until such time as more progressive policies are instituted.
More progressive taxes are one such policy. JimV and Jack mentioned higher taxes on the rich. Yet, Is that monetary policy? Does the Fed have control over tax rates? Would the Fed encourage strong progressive tax rates in the same way they encourage more fiscal stimulus? As deflation and poor labor conditions were persistent during the economic growth of the Gilded Age, eventually the concerns of the people were heard and progressive income taxes were instituted across many nations. The first income taxes fell primarily upon the rich. (source for income tax history)
Mark Sadowski also mentions that we need expansionary policy. Yet, the current expansion is primarily among the rich, not the 99.9%. Dannyb2b points out that the wealth effect concentrates wealth among the rich and “The solution I see is to create a wealth effect that affects all people”. So expansionary policy is great, but the expansion manifests as expanding inequality… not good. Thus, the original question to our readers.
So can monetary policy change to reduce inequality?
Marko cuts to the chase: “In a way , this question has no reasonable answer. It’s equivalent to asking what the Mafia or Mexican drug cartels could do to reduce drug use and crime… I don’t know the extent of the Fed’s bank supervisory powers , but I think they could make an impact with some bold actions against big finance.”
Marko is implying that the Fed exists to serve the rich, who might either have vices/addictions or social concerns. Either way, the Fed works its policies through the rich. Ultimately the rich decide what to do with the money, such as investing overseas or increasing their own capital share of national income. The rich defend themselves by saying, “a rising tide lifts all boats”. With that logic, labor is sunk. However, Janet Yellen took over the Chairwoman job by saying the Fed must serve all people. So does that mean that the Fed could take bold actions against big finance as Marko says? Have we even seen any bold actions from the Fed against big finance?
There is a bigger picture to all this given by Vernon Bush. Maybe capitalism itself creates inequality…
Vernon Bush: “All these comments presume that any solution will still unfold within a Capitalist system. I am now considering if the Capitalist system can continue to function to the betterment of society and its people in a world where there will continue to be less and less work… The bigger question is can capitalism even work in such a system? I think not as all wealth will flow to a very, very few which we see happening now and will see happening increasingly in the future. This is unstoppable in a capitalist system and tinkering with Fed rates, distribution, tax policy, etc is just that… tinkering… and not a real fix. I frankly don’t know what the real fix is but doubt it will be found in a Capitalist system.”
An alternate form of capitalism involves a high percentage of Cooperatives which distribute wealth through shared ownership of capital. Cooperatives reduce the spread between the pay of CEOs and workers. Even though cooperatives are the fastest growing form of business structures, they are unrelated to monetary policy by the Fed. So they do not answer the question posed on monetary policy and inequality.
So what is the conclusion? Is monetary policy unable to affect inequality? Does society just slide down a muddy slope into “patrimonial” capitalism, a kind of neo-feudalism? Do our rants and raves to stop this process simply echo into the yawning chasms of deep space?
Rjs offers these guiding words: “it is easier for a camel to pass through the eye of a needle than for a central banker to reduce inequality..”
We give thanks to our readers for their individual inputs…
You asked the wrong question. The Fed cannot reduce inequality. That’s not it’s job. It is the job of fiscal policy to look after “the general welfare,” which would “reduce inequality” by finding work for workers, and by limiting the profits to criminal banks and other “enterprises.”
And yes, capitalism inevitably leads to inequality. That does not make it necessarily evil. It is the job of government to see that some of the money that accrues to “capitalists” is recycled to the general economy when capitalism can no longer do the job, as happens frequently. Especially under the guidance of “monetary policy” and central bankers who naturally see the world through the eyes of the capitalists… or at least the “financialists.”
But then to what extent is monetary policy making inequality worse, if it cannot reduce it?
Use this common analogy between monetary policy and the engine of a car. You push down on the accelerator like pushing down on the Fed rate, and the car goes faster. You are saying that monetary policy is NOT steering the car toward inequality,but rather fiscal policy. And, the car is racing towards massive inequality. If you cannot steer away from inequality, couldn’t you at least slow down the car a little before it goes over the cliff? put on the brakes a little? slow down monetary policy?
If you don’t, your society will crash into inequality much faster and much more violently.
Monetary policy is making it worse because of the structure of the economy that government policy (whether law passed or law enforced or not) built. The Fed is captured by that and the laws governing its mechanics (which are the materialization of its mandates etc.)
The Fed’s results are totally depended on the structure of the economy. Change the economy and the answers to your question become different. It might not even be a question as to inequality and the Fed role.
i think your analysis of how fed policy can make inequality better by not making it worse is a little rube goldberg-ish.
I take it that a policy of high interest rates that would lead to a recession resulting in less income to workers and more… for a while… to holders of bonds… would increase inequality. I am not sure that not raising interest rates would decrease inequality… something about pushing up a rope.
in fact, i take it that the fed is a bit like a caterpillar that has only learned to walk with one leg… so it only goes in circles.
if you want to increase equality… try something direct, like creating jobs, with federal money if the money-boys won’t or can’t do it on their own “because the economy is so bad.”
then, and especially, find an honest congress to go after the ways the money boys make people poor by fraud and abuse.
but you aren’t going to get there with an attitude of “oh no we can’t do that, it would frighten the markets, and the entrepreneurs would sulk in their tents.”
Just a brief comment:
Lots of idle capacity and little demand. I saw that capacity in Shanghai and the surrounding areas. I saw it in two $1 billion investments for a company which will make all of the bearing forgings for bearing machining manufacturers in a $1 billion casting and forging facility and its own finished bearings in a $1 billion machining facility. The plants were impressive and impressively idle. Imagine a bearing > 2 meters. The equipment exists in this facility.
Acres of stores in giant malls. Masses of completed housing ready to be occupied and empty. So China invested in GDP and not in people. The split is not even in the investment and the impact greater for business as compared to people. They kept people busy building; but, it stopped there.
Society is slowing waking up to the dangers of inequality. Piketty is just now getting some high economists to realize the danger. The society needs time to mobilize a response to inequality which is coming faster than people are able to respond to it.
Thus, you have to buy time for society to form a response.
If you simply want to return to full employment, and are content with that, you are walking into a trap. Inequality will be so entrenched, so hard to reverse, that the real battles will be much harder to fight, let alone win.
I place inequality at the top of my list of problems to solve, even above full employment. And when I see monetary policy speeding toward it, I feel like a passenger in the back seat cringing in fear because the person at the wheel (fiscal policy) and the engine (monetary policy) are racing toward inequality. and I want one of them to react.
Creating jobs is a non-issue, unless labor share can rise at the same time. Otherwise, the extra income generated simply goes upward to capital income as it circulates through the economy.
Labor has little power, but it is growing. You need to give labor time to gather their strength. Slowing down monetary policy gives labor more time.
Inequality is not just an economic issue. It is a social transformation of growing conflict that takes years to develop. and it is developing, but it takes time. Inequality is entrenching must faster and in ways that people barely see.
Maybe this logic is rube goldberg-ish, which means something contrived and complicated which is actually simple. You think that job-creating is the simple straight forward solution. You are falling right into a trap. By the time you have your unemployment, and labor share is still low, and the Fed rate is still below 2%, when it should be 4%, you will look around you and find data everywhere on how bad inequality has gotten and how it is still getting worse because of the unusually low Fed rate for years and years… and you and society will be in a trap. You will have dug yourself into a hole.
Then you will see real aggression and anger. You will see high student default rates that will tip the balance. You will see China stumbling from its excesses. Inflation will stay low because China will keep its factories producing by government policy. The markets will still be flooded by products at low prices. Jobs will not come back as Noah Smith predicts. Labor share will continue to fall as Chinese capitalists try to survive. Wages will not increase here either for the same reasons.
So we are in a car speeding toward a sign that says “full employment”, but as we break through the sign, you will see the cliff on the other side. and it will be too late to stop and turn back without a lot of conflict and struggle.
It is great that you were able to go see China with your own eyes. You realize the unsustainable nature of their problem. The Chinese government will try their best to cover over the problem and keep factories working to maintain low priced goods in the global market at some level of over-saturation, suppressing inflation pressures and even incentives to return manufacturing to the US. US manufacturers still know that China can produce lots of products at cheaper prices, even if they were to implode.
The Fed reduces income inequality by smoothing-out business cycles, to maintain sustainable growth, which is optimal growth.
Without the Fed, actual output would be much farther away from potential output and the country would be below or beyond full employment.
Without the Fed, there would be economic boom/bust cycles, which are inefficient both in the boom and bust phases, because of periods of strain and slack.
When more Americans are unemployed and underemployed, there is greater income inequality.
Also, I may add, the ultimate goal of the Fed is to improve living standards for the masses as steeply as possible through sustainable growth in the long-run.
Without the Fed, growth and employment would be farther away from optimaI, or suboptimal to a greater extent.
I stated before:
The Fed has been very effective smoothing-out business cycles, resulting in faster (and compounded) economic growth (of course, other factors also contributed to faster growth, including fiscal policy and the establishment of the minimum wage).
Average annual per capita real GDP growth:
1913-2012: 2.04% (after Fed)
1813-1912: 1.38% (before Fed)
You used the most important word… sustainable.
Do you see high levels of inequality as sustainable?
Edward, I’m for bringing up the poor, not bringing down the rich.
And, it should be noted, more employment means more tax revenue and less spending on the unemployed to help the really needy,
I am not saying you are wrong. I am saying you are not clear.
I don’t see how creating jobs fails to increase labor share. I don’t see how better policing of fraud in big companies… as a business model… fails to increase effective labor share… that is workers get to spend their money on what they want and need rather than have it stolen or extorted from them by deceptive business preactices.
In fact I would benefit from higher interest rates… at least “directly.” but i don’t see how labor share benefits from it. Perhaps you have already explained this… but the “explanations” i have seen look a lot like arm waving and, frankly, appeals to “models”, which i have learned not to trust.
“Edward, I’m for bringing up the poor, not bringing down the rich.”
You want to bring up the poor only if the rich benefit first. If the wealth owners feel richer then they may spend a little more or if the big banks experience lower funding costs they may lend a little more. Its trickle down economics.
We need to create a wealth effect that is balanced were all people increase wealth and this is easily performed by money transfers to public with reference to fed goals. This will also remove excessive dependance on credit keeping credit at safer levels.
Depending overly on banks to create credit and depending on a wealth effect by the owners of wealth is certainly unsustainable and imbalanced.
Eliminating The Fed would be the FIRST REAL move toward sustainability.
Its a “Print All Ya Want” money system, Folks.
The Treasury could PRINT money just as easily as The Federal Reserve. The Treasury could then charge interest just like Goldman-Sachs and start paying down the deficit.
Dannyb2b, it’s not a zero sum game. Everyone benefits from more output and employment, directly or indirectly.
I’ve explained to you more than once before, the Fed just giving away money to poor people would not only destroy the dollar and cause demand for another currency or gold, it would make U.S. monetary policy ineffective (in creating and destroying money to smooth-out business cycles) and cause a deep depression, that would be very difficult to get out of.
Faith based proclamations are not explanations.
Bruce, I agree. I’m still waiting for rational explanations from some people.
Actually The Treasury could just PRINT OUR way out of debt.
Banks (including the Fed) are instruments of debt creation. Eliminate that middle man, that need to borrow, get out of debt and PRINT OUR way to prosperity.
Federal Reserve Notes aren’t backed by anything, no gold or silver, just faith in The USA. Treasury could PRINT just as good a product or better. I, for one, have more faith in Treasury than I do in The Fed. That would put Money in DIRECT CONTROL of The Congressional Banking Committee and Congress in general.