At a recent press conference, I was dismayed to see a number of reporters asking Jay Powell about inequality—an issue far beyond the scope of monetary policy—while asking few questions about the highly questionable current stance of monetary policy.
A recent Yahoo Finance article illustrates the confusion:
Federal Reserve Chairman Jerome Powell on Wednesday acknowledged economic inequality in the United States but said monetary policy tools can only do so much to narrow the income gap.
Research from within the Fed itself, however, suggests that the central bank may be more effective when policymakers pay mind to income inequality while designing policy tools.
Actually, inequality is a long run issue and the Fed cannot do anything to address the problem. Money is neutral in the long run.
Pointing to previous economic research, Cairó and Sim note that higher-income groups tend to save more than lower-income groups (or in economic terms, have a lower marginal propensity to consume). The authors argue that higher-income earners can “overaccumulate” financial wealth and sustain high savings rates; lower-income earners are more likely to spend larger shares of their income just to make ends meet.
This presents a dilemma for the Fed, which broadly wants to discourage saving and spur consumption (or in economic terms, drive aggregate demand) to fuel an economic recovery.
This is a common mistake, conflating “consumption” with “aggregate demand”. Most textbooks say the opposite, that monetary stimulus is aimed at boosting investment. Because saving equals investment, this implies monetary policy is expected to boost saving as well. Indeed both saving and investment are procyclical, even as a share of GDP. They both rise faster than GDP during booms and fall faster than GDP during recessions. (Note that I am responding to the Yahoo article and not the scientific paper, which I have not read.)
I also disagree with the standard textbook description of the transmission mechanism. Aggregate demand equals consumption plus investment plus government output plus net exports, and hence you can think of monetary policy as being intended to boost the sum of those four categories, measured in nominal terms. Or more simply, boost NGDP. Thus Zimbabwe monetary policy sharply boosted nominal spending in 2008, even as real consumption and real investment plunged. (Try explaining this to an MMTer.)
The suggestion: an “optimal” monetary policy prioritizing the reduction in unemployment to improve the welfare of lower-income wage earners – even at the expense of welfare losses to higher-income earners holding onto financial assets.
The monetary policy that boosts employment in the short run is the same policy that boosts real equity prices in the short run—expansionary policy. In the long run, the optimal monetary policy keeps employment close to the natural rate, and that’s also the monetary policy that’s best for equity prices.
Readers of this blog know that I currently favor a more expansionary monetary policy. But not because of its effects on inequality. In the short run, a more stimulative policy would help low wage workers and it would help stockholders. And in the long run, money is neutral. If you want to do something about inequality, look elsewhere.
Meanwhile reporters need to ask the Fed why they don’t intend to hit their inflation target in 2022. And keep asking the question over and over again until Jay Powell provides an intelligible answer.
READER COMMENTS
Ahmed Fares
Jun 13 2020 at 4:24pm
“Try explaining this to an MMTer.”
Bill Mitchell covered Zimbabwe in an article titled: Zimbabwe for hyperventilators 101
Link: http://bilbo.economicoutlook.net/blog/?p=3773
Garrett
Jun 14 2020 at 12:16pm
Seems like a weird thing to exclude from inflation.
Mark Z
Jun 13 2020 at 5:17pm
Great post, though I’m guessing “net experts” is supposed to be “net exports.”
Scott Sumner
Jun 13 2020 at 11:04pm
Thanks, I fixed it.
Shyam Vasudevan
Jun 13 2020 at 7:00pm
I think the premise of the question is correct in that monetary policy does have distributional consequences. We need expansionary policy that favors low income debtors over high income savers.
Kevin Erdmann
Jun 13 2020 at 8:10pm
That is more of a young-to-old transfer than a low income-to-high income transfer. And also probably more of an innovative industry-to-mature industry transfer. For instance, the lost face value on fixed rate bonds would help utilities but not so much Apple and Google.
Scott Sumner
Jun 13 2020 at 11:05pm
You said:
“monetary policy does have distributional consequences”
Only in the short run. Inequality is a long run problem.
Jose Pablo
Jun 17 2020 at 11:32pm
Are you sure debtors are low income?
Try to get a loan from a bank being “low income” … good luck!
Try to get a loan from the same bank using your Private Equity investments as a collateral and showing them your last year tax filling with income in excess of 1 million US$ …
And if you happen to have a marginal account at your broker, you can just transfer the “margin loan” funds to your bank account, no “approval” required … sure “low income” guys hold the mayority of marginal broker accounts out there
I am always amazed by the prevalence of the narratives even when they are totally disconnected from our day to day lifes … never let the facts confuse you …
Mike Sandifer
Jun 13 2020 at 11:52pm
Scott,
The.problem with you saying that monetary policy can only affect distributional issues in the short-run, is that the short-run is considerably longer than it was a generation ago. Market monetarism has a problem, to the degree that it is claimed that markets should be taken seriously and and that sticky wages adjust within a handful of years after a shock. The fact is, Treasury yields are tremendously depressed going out 30 years versus just few months ago. So, are Treasury markets less than reliable, or does monetary policy work fundamentally different in some ways near the zero lower bound with an inflation targeting regime? I’m betting the answer is primarily the latter.
There is, in effect, no short-run anymore.
Scott Sumner
Jun 14 2020 at 2:18am
The low Treasury yields reflect both slower expected inflation and lower real rates due to non-monetary factors.
They do not suggest long run non-neutrality.
Mike Sandifer
Jun 14 2020 at 11:03am
Scott,
If history is any guide, wages will adjust within about 5 to 6 years, as occurred after the Great Recession. Is this what you mean when you claim money is still neutral in the long-run?
You refer to “non-monetary factors” as an unexplained explanation for low rates going out 30 years. What are those factors, and why did they change with the nominal shock component of the present downturn? Do you think there will be highly significant real effects of this crisis 30 years from now? Since rates only changed suddenly, with the beginning of the current shock, why shouldn’t I believe that the current inflation targeting regime isn’t even more disinflationary near the ZLB than otherwise?
Scott Sumner
Jun 14 2020 at 12:06pm
The social distancing has led to a huge rise in saving, which depressed interest rates.
Mike Sandifer
Jun 14 2020 at 1:42pm
Scott,
Okay, so we shouldn’t interpret the change in the 30 year rate as indicative of the market forecast for where the Fed will have rates in 30 years. It’s true that the savings rate it’s way up due to lack of spending opportunities recently and so your claim seems reasonable on the surface.
The problem is, we had a larger though slower drop in the 30 year rate during the last nominal shock, associated with the trade war(far larger than the real shock), and we’ve seen this pattern with other nominal shocks since nearing the ZLB. For example, the drop in the 30 year rate was even greater during the Great Recession.
Scott Sumner
Jun 15 2020 at 1:05pm
Don’t forget that the yield curve has also steepened sharply, so forward rates have fallen by much less than spot rates.
Mike Sandifer
Jun 15 2020 at 5:30pm
Scott,
True that the yield curve has steepened since the trade war eased, but doesn’t that just indicate that the initial real and nominal shocks were eased somewhat? Long rates are still significantly lower than they were. Am I missing something?
kevin
Jun 14 2020 at 12:14am
I’m not even sure about the short-run implications of bad (deflationary) monetary policy on inequality. I’m sure the rich also don’t like it when the prices of all their assets fall and their businesses collapse. I think you could make a plausible argument that deflation lowers measured $ inequality simply because the poor don’t have much room too fall. Don’t tell stephanie kelton though, or she’ll write a new book about using taxes to deflate inequality away…
Thomas Hutcheson
Jun 14 2020 at 7:44am
Why do we have “journalists” that refuse to actually ask about the Fed’s deflationary policies? “Mr Powell, is it still Fed policy to have the PCE rise at an average of 2% p.a.? Is that policy consistent with a 5-year TIPS CPI inflation expectations rate of less than 1%?
Market Fiscalist
Jun 14 2020 at 9:44am
‘Thus Zimbabwe monetary policy sharply boosted nominal spending in 2008, even as real consumption and real investment plunged.’
Was it monetary policy that drove the Zimbabwe inflation ? It seems way more likely to me that the government just run huge deficits. That is: it was fiscal policy that drove the inflation. I’m fairly sure that is also what MMTers would think.
Scott Sumner
Jun 14 2020 at 12:04pm
Deficits are not inflationary unless they are paid for by printing money. It’s the money that causes the inflation.
Market Fiscalist
Jun 14 2020 at 1:15pm
Well, yes. But if the Zimbabwean government just paid for a load of stuff by creating new money that’s still fiscal policy , isn’t it ?
Garrett
Jun 14 2020 at 3:05pm
I think the idea is creating money is monetary policy, spending money is fiscal policy. Created money can be invested in assets, so not all monetary policy actions are fiscal policy actions. Government spending can be sourced from created money or borrowed money, so not all fiscal policy actions are monetary policy actions.
Market Fiscalist
Jun 14 2020 at 4:51pm
Whenever a government runs a deficit then by definition it creates new money doesn’t it ? Normally this isn’t inflationary because the government and the CB between them then work it out so that just enough new bonds are sold to the public so that an inflation target can be hit (I assume that Zimbabawe didn’t bother with that stage!).
So to me it seems like there is useful distinction between money creation via buying of assets (that I would call monetary policy) and money creation via government deficit (that I would call fiscal policy) but I’m fine with not making this distinction as long as its done consistently.
Garrett
Jun 14 2020 at 9:08pm
A government can run a deficit without any money creation if they sell bonds to the market. The cash the receive already existed in that case.
One way to think about this is EM countries that raise dollar-denominated debt. They get cash to finance their spending, but they obviously didn’t create any new money. Just the same, if the Fed isn’t buying the bonds, then the treasury is raising money without any new money being created.
Market Fiscalist
Jun 15 2020 at 1:19am
Yeah, but we’re not talking about EM countries or the USA. We’re talking about Zimbabwe in the inflationary era where (as far as I can tell) the government caused the inflation purely by deficit spending funded by money creation. Any thought that the government could have sold enough bonds to stop the inflation given the level of deficit spending seems far-fetched to me.
Garrett
Jun 15 2020 at 8:01am
Exactly, we’re talking about what caused the inflation. A government can run huge deficits but if there’s no money creation (or more precisely, money creation that’s expected to be permanent) it won’t cause inflation.
You originally asked:
So the answer is yes, it was monetary policy (money creation) that drove the inflation. Just running huge deficits isn’t enough.
Market Fiscalist
Jun 15 2020 at 9:26am
Thanks Garrett. I don’t think we are in disagreement. If one wishes to categorize all money creation as monetary policy even when its done by the government to fund its current spending I have no objection to that.
Garrett
Jun 15 2020 at 9:48am
Yeah I think you have to separate the two. If you just look at deficits you’ll have a tough time explaining why inflation in the US accelerated in 98/99/00 when there were budget surpluses but decelerated in 08/09 when there were huge deficits.
Philo
Jun 14 2020 at 11:43am
You wrote: “reporters need to ask the Fed why they don’t intend to hit their inflation target in 2022.” They also needed to ask this question about the 2010 or 2011 inflation target back in late 2008 and early 2009. But they didn’t do it then, and they probably aren’t going to do it now. Our financial reporters are consistently disappointing.
Benoit Essiambre
Jun 14 2020 at 12:03pm
I disagree that monetary policy can’t help with inequality. Recurrent periods of unnecessary high unemployment and underemployment because of insufficiently stimulative monetary policy are probably one of the main driver of inequality.
Because of cost of capital or “hurdle rate” business mechanisms, the most vulnerable and the poorest are often first to lose their jobs, have their careers stunted and lose their human capital. Because of non-ergodicity of bad luck, these effects can compound long term and keep them fragile and first to lose their jobs again during the next recession.
Scott Sumner
Jun 14 2020 at 12:05pm
America became less unequal during the 1930s. Wasn’t that a period of “high unemployment”?
Mike Sandifer
Jun 14 2020 at 2:16pm
I think the broader point is that the least productive workers tend to get laid off first and are the last hired, in average, and labor compensation does correlate with productivity. In that sense, bad monetary policy can certainly exacerbate wealth inequality, as it hurts the poor disproportionately, though it hurts almost all rich people too.
Don’t know why you would bring up the 30s, as if it were a relevant counter-example here, given the seemingly obvious observation above, and given that there was unprecedented intervention in the economy in the 30s, including wage floors, and establishment of Social Security and unemployment compensation. You’ve said before that productivity rose during the Depression, so perhaps that’s what you were referring to. However, to the degree that happened, it was a rate, not a level phenomenon, right?
Mike Sandifer
Jun 14 2020 at 3:06pm
I was really sloppy in my reply here. You’ve said productivity rose during the 30s, but the level of production was obviously depressed, due to unemployment. The vast numbers of unemployed were likely not better off, even with unemployment compensation.
Scott Sumner
Jun 15 2020 at 1:07pm
Yes, unemployment increased, but I thought we were talking about inequality.
Mike Sandifer
Jun 15 2020 at 5:31pm
Unemployment, which obviously increases inequality, which was the biggest problem, and the level of productivity. For example:
https://www.minneapolisfed.org/research/quarterly-review/why-did-productivity-fall-so-much-during-the-great-depression
Michael Pettengill
Jun 14 2020 at 1:10pm
And investment means paying workers to build capital.
All savings must be paid to workers to build capital which secures the investment in a firm, or secured the debt used to build capital.
The absurdity of the past few decades is calling it investment to fund buying food, clothing, energy, or to fund paying $10 for an old asset that cost $5 to build, and that has depreciated so its remaining values is $2.
If the price of something that cost $5 goes from $5 to $10, that’s called inflation. But today, the price of something that cost $5 to build a decade ago going to $10 is called “creating wealth”.
The classic model of substitutes has been discarded. A building lot seems to not allow substitution because moving from LA or SF to California City where new housing and factories and retail can be built for labor costs can not be allowed because it would “destroy wealth”. If California City, or any town in Iowa, Kansas, Ohio, West Virginia, were a substitute for LA and SF, the prices of capital in LA and SF would crash, taking the financial sector with it as the assets backing one million mortgages would fall to half a million or less, still higher than the labor costs to build many of them, but a price too low to repay the savers who made the debt possible.
The financial sector must redline cheaper cities and towns to protect their bad investments in a few cities like LA and SF. They then declare price inflation of old capital due to artificial scarcity to be wealth creation, not inflation.
Todd Moodey
Jun 15 2020 at 8:36pm
How ironic, then, that the Fed has today embarked upon a policy that is almost certain massively to increase inequality in a very short time. The announcement that it will buy corporate bonds, which will undoubtedly be followed in due course by a similar announcement with regard to equities, will enrich the already wealthy but do nothing, or very little, for the man on the street who’s wondering how he’ll pay the bills while unemployed.
It’s a sad day for true free markets when the government decides to (try to) become the world’s largest securities manipulator. I have little doubt, too, that this will become enshrined in policy. Politicians will find it too tempting to resist calling on the Fed to juice the market with even the slightest downturn.
Matthias Görgens
Jun 17 2020 at 12:47am
It doesn’t really matter all that much what assets the Fed is buying, as long as they buy them at market prices.
(And any impact in the holders of those assets happens when the public first credibly learns about the new policy. Not when the Fed buys anything. Efficient markets anticipate the buying.)
Todd Moodey
Jun 17 2020 at 10:02am
You’re right–the market will come to expect the Fed to support stock prices. Is that a good thing? Is “too big to fail” a good thing?
Roger Fox
Jun 16 2020 at 1:08pm
I read that according to the results of the meeting of the Federal Committee for Open Markets, the Fed kept interest rates at the current level near zero, saying that it “doesn’t even think” about the increase. The central bank gave its cautious forecasts for GDP growth, employment and inflation. But the largest US stock indexes at the close of trading on Wednesday did not show a unified dynamics against the background of news about the Fed’s interest rates at the same level.
Matthias Görgens
Jun 17 2020 at 12:48am
It’s always hard to judge market reaction against Fed news, because the market doesn’t react to the absolute contents of the news, but to how they differed from what the market already expexted.
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