The newfound welcome shown by senior FRB officials for Fed Up has drawn widespread press attention but should be viewed more as a bit of positioning for next year’s political firestorm than genuine sympathy for the progressive push to set interest rates still lower and open the Fed’s portfolio to even more assets. Absent renewed crisis, no one at the central bank has any intention of taking either of these actions. However, that the FRB is deaf to this progressive line of attack shouldn’t make it blind to the income-inequality impact that powers up movements like Fed Up and so many others in this very unhappy election season. As a forthcoming FedFin paper will make clear, these income-inequality effects are far-reaching and warrant rapid action by the FRB on the monetary- and regulatory-policy distributional drivers for which it can rightly be held accountable.
In an op-ed Wednesday in the Wall Street Journal, former FRB Gov. Kevin Warsh offered a stunning statistic showing just how linked equity-asset prices are to what the FRB does. This rightly addresses the single-minded focus now on each central-bank utterance, a monomania that distracts from meaningful valuation and productive investment. It’s important, though, to go beyond the day-to-day linkage between central-bank action and equity prices to look more deeply at what the FRB has done to a broad class of financial asset prices and valuation.
As a recent BIS study has shown, accommodative policy creates sharp valuation differences between the financial assets held by wealthier people (stocks, bonds, etc.) and the few alternative assets available to low- and moderate-income individuals (principally home ownership). Accommodative policy is designed to force banks to make lots more loans that fuel housing lending to generate one source of wealth accumulation and to also give banks the funds they need to make lots of small-business and corporate loans to boost sustainable employment. But, as is all too evident, money is staying stuck in equity and other financial assets and not moving through to broader productive use. Fortunes are made or lost based on day-to-day market volatility, but the employment needle is moving only stubbornly upward and house-price appreciation is largely to the good of upper-income families, not first-time homeowners.
Why is this? An in-depth FedFin analysis of challenges to U.S. policy goes into this in detail, but a key reason for the distributional impact of accommodative policy lies in the new regulatory framework and the roadblocks it throws up to traditional financial intermediation. The FRB expected banks to pass through the trillions provided through quantitative easing, but these trillions have largely stayed stuck in non-productive assets. The rules aren’t the only reason, but we have shown that they are a very important one.
Another significant distributional cost of current FRB policy is interest rates so low that they have become a tax on savings. Ben Bernanke and others acknowledged this risk even as they pushed rates down close to zero. They believed pain for folks who couldn’t afford financial assets like high-flying equities would ultimately lead to gain as consumer spending ramped up in the absence of savings returns and deposits were forced into the economy. This could well have worked if rates stayed low for a short period of time, but rates have been abysmal for as long as most folks remember.
Without safe places to put funds at real rates of positive interest that promote wealth accumulation, lower-income people will keep spending what they have even as this consumption continues not to promote sustainable, employment-generating growth. Still more startling, Americans who can put a bit aside are saving anyway, accepting negative real rates out of fear that anything they do with what little money they have will be lost just as all their savings were during the crisis. This creates a downward drag on larger purchases such as cars and houses that promote employment even as lower-income people are lining up for higher-cost goods often manufactured outside the U.S. And, retirees forced to live on prior savings are just getting ever poorer, creating a tremendous social-welfare problem with no positive economic results and at great human cost.
But, just as the market shouldn’t be monomaniacal about FRB interest-rate policy, the FRB isn’t the sole root of distributional evil. Income inequality is due to far more than the unintended consequences of very low rates for a very long period of time during which fiscal policy-makers have done their best to flummox growth and geopolitical events have done nothing but make matters worse. And it’s important to note that the FRB is also concerned about income inequality – indeed, Janet Yellen gave a groundbreaking speech on this last year making it clear how distressed it makes her and her colleagues. She raised these issues again this morning in Jackson Hole.
Her speeches do, though, focus only on the income-inequality drivers outside the FRB’s reach – fiscal policy, obstacles to social mobility, educational challenges, and the like. There’s a lot of work to be done on all of these fronts. However, the Fed can and should do much on its own to focus monetary policy not just on idealized “neutral” interest rates, optimal inflation, or “full” employment. As Mr. Warsh said, these questions keep the economist “guild” in full throttle – think of all the dissertations and professorships to come out of this crisis!
To solve at least a bit for income inequality we have to look away from what the FRB loves to parse and look to those that speak loudly to an awful lot of pain in the populace with darn little gain for the economy. Letting rates move into ranges where rational economic decisions by individuals and institutions reap reasonable returns would do a world of good to improve income distribution even if a great deal more still needs to be done.