The Fed’s heavy hand on economic equality

Monetary policy and bank regulations contribute to widening US wealth gap

The US Federal Reserve insists it is exiting quantitative easing because the economy no longer needs the stimulus it provides. In reality, QE has benefited the haves at the expense of the have-nots and will be very hard to reverse, especially in light of post-crisis banking rules such as the liquidity coverage ratio (LCR), which make it challenging at best for the Fed to lower its asset portfolio to anything close to pre-crisis levels.

As the Fed reverts to a more conventional monetary policy, it must address the negative side-effects of QE and enact rule changes that encourage banks to lend and take deposits, rather than simply hoarding safe assets to meet regulatory ratios.

It is bad enough that a huge Fed balance sheet distorts asset pricing and allocation across the global economy, but from a social welfare and political stability perspective, it is still worse that QE has increased the already wide gap in US income and wealth equality.

The Fed’s QE defence – voiced by chairs Ben Bernanke, Janet Yellen and Jerome Powell in turn – is that post-crisis monetary policy was equalising because it prevented a Great Depression, and the Great Recession is transitioning to “full” employment, thus reversing the short-term income inequality effects.

Employment, though, is full only if you think that multiple wage-earners in a single family, each working multiple jobs, makes for prosperity despite the lack of meaningful wage growth in recent decades.

GDP is similarly robust if you average productivity gains across the population as a whole. Account for distributional effects and all too many Americans are stuck in seemingly endless recession. Aggregate totals tell us nothing about economic equality, which is clearly profound judged by any number of studies, calculations and analyses.

Critical microeconomic divides show even more clearly the adverse distributional effects of post-crisis monetary and regulatory policy. A scarcity of safe assets has sparked yield chasing and asset-price bubbles at considerable benefit – at least so far – to the richest among us.

Not only do new banking regulations redefine financial intermediation – especially in the US – but they also create a negative feedback loop with post-crisis monetary policy

An influential recent study from the Bank for International Settlements found the US has become sharply more economically divided, in part because financial asset valuations have risen faster as a result of QE than the value of savings and homes, which are critical to lower-income household wealth accumulation.

In the period immediately after the crisis, the asset-growth differential between the richest quintile and second-poorest quintile was between 4% and 8%. Even though housing started to function as an inequality decreasing force around 2012, stock returns have still grown at a faster rate, resulting in asset-growth differentials of generally around 2% during this period. Since then, the gap has widened because the market did better.

In the US, low- and moderate-income households hold their wealth (when they have any) very differently than the rich. The top 10% hold about half of their wealth in financial assets, such as stocks and bonds. Financial asset holdings dwindle as one gets below the 75% wealth threshold until one gets to the bottom 25% of the population, who have more debt than assets and rely on housing for the bulk of what they own.

This means ultra-low rates do grievous damage to those who can least afford it. They throttle macroeconomic growth because banks simply cannot earn a return by making loans. And they suppress the ability of lower-income households to get ahead by putting a little bit aside in a savings account or by contributing to a retirement plan.

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The week on Risk.net, October 17-23, 2020