The Distributional Consequences of Monetary Policy

Nick Rowe asks if the distributional consequences of Monetary Policy are bad and says “No”:

“But mostly, I think Ashwin is asking the wrong question. I can’t stop people asking the question “would loosening monetary policy to increase aggregate demand cause the distribution of income/wealth to worsen?”. My guess is that some people would indeed be made worse off, like people who hold a high proportion of their wealth in safe nominal bonds (though I’m not sure if that counts as a worsening of inequality or not). But I can’t imagine that anyone would use that as a reason for not increasing aggregate demand. After all, those who would probably benefit the most would probably be those with the highest risk of unemployment, who are likely to be among the most poor. I hope nobody would argue “we just have to live with the recession, because if we cured it some rich people would benefit”.”

This is a response to an article by Ashwin Parameswaran, where Ashwin makes it clear the fed buying real world assets is fiscal policy.

“A quantitative easing program focused on purchasing private sector assets is essentially a fiscal program in monetary disguise and is not even remotely neutral in its impact on income distribution and economic activity. Even if the central bank buys a broad index of bonds or equities, such a program is by definition a transfer of wealth towards asset-holders and regressive in nature (financial assets are largely held by the rich).

But the more interesting part is the next parts (bold mine):

“The very act of making private sector assets “safe” is a transfer of wealth from the taxpayer to some of the richest people in our society. The explicit nature of the central banks’ stabilisation commitment means that the rent extracted from the commitment increases over time as more and more economic actors align their portfolios to hold the stabilised and protected assets.”

Such a program is also biased towards incumbent firms and against new firms. The assumption that an increase in the price of incumbent firms’ stock/bond price will flow through to lending and investment in new businesses is unjustified due to the significantly more uncertain nature of new business lending/investment. This trend has been exacerbated since the crisis and the bond market is increasingly biased towards the largest, most liquid issuers. Even more damaging, any long-term macroeconomic stabilisation program that commits to purchasing and supporting macro-risky assets will incentivise economic actors to take on macro risk and shed idiosyncratic risk. Idiosyncratic risk-taking is the lifeblood of innovation in any economy.

In other words, QE is not sufficient to hit any desired inflation/NGDP target unless it is expanded to include private sector assets. If it is expanded to include private sector assets, it will exacerbate the descent into an unequal, crony capitalist, financialised and innovatively stagnant economy that started during the Greenspan/Bernanke put era.”

Let me assure you this “transfer of wealth to the richest people in our society” and massive bias “towards incumbent firms and against new firms” didn’t start when Bernanke started buying real world assets.

This massive distortion happens as a matter of course with stimulative monetary policy. It’s been happening for 30 years as we slowly ground our rates to zero.

Why? Why is this the case?

Lowering interest rates doesn’t just cause more economic activity. Lower interest rates also causes asset values to rise. It causes people who own assets to see those assets go up in value.

Lower the discount rate, and the value of assets goes up, by definition. Lowering interest rates has a balance sheet effect on existing assets.

In short, monetary policy causes the rich to get richer without lifting a finger. That’s a distributional consequence, right?

But that’s not the end of the consequences of using monetary policy. We know something about our economy. We know if we want it to move away from equilibrium into growth over the long run, some sector needs to go into deficit.

Here’s Wynne Godley:

“It is thirty years since Carl Christ, of Johns Hopkins University, had the brilliant insight that should an economy ever reach stationary equilibrium, all stock variables as well as all flow variables would be constant; and that if all stock variables, including government debt, were constant, government receipts would have to equal government payments. It would then follow that if the economy were moving toward stock-flow equilibrium and if taxes were levied as a proportion of income, the GDP of a (closed) economy would always be tracking, perhaps with a long lag, government outlays divided by the average tax rate – the very same concept that we call fiscal stance. Therefore, a necessary condition for the expansion of the economy, at least in the long term, is that the fiscal stance should rise: Government expenditure must rise relative to the average tax rate. If the tax rate were held constant, government expenditure would have to rise absolutely for output to grow; if government expenditure were held constant, the tax rate would have to fall.”

How can an economy grow in the long run if the fiscal stance does not rise?

One answer: Ever more debt.

How can we be assured of creating more debt? Lowering interest rates.

What happens when we lower interest rates? We make private sector owners of assets richer, due to the lower discount rate on their assets.

Since this path of ever more debt must continue to get the economy to grow, and the only way we’ve done this for 30 years is to lower interest rates, monetary policy makes asset owners richer.

This is what happens:

““The very act of making private sector assets “safe” is a transfer of wealth from the taxpayer to some of the richest people in our society. The explicit nature of the central banks’ stabilisation commitment means that the rent extracted from the commitment increases over time as more and more economic actors align their portfolios to hold the stabilised and protected assets.”

Such a program is also biased towards incumbent firms and against new firms. The assumption that an increase in the price of incumbent firms’ stock/bond price will flow through to lending and investment in new businesses is unjustified due to the significantly more uncertain nature of new business lending/investment.”

Now, of course, the gig is up and we can’t lower nominal rates any farther. So we need to do the equivalent – which is buy real world assets from rich people.  and it’s 100% obvious something like the Central Treasury Reserve Bank needs to purchase real world assets for credit to grow and therefore get our economy going.

But lowering interest rates has exactly the same effect as buying real world assets to the owners of assets. It causes the value of their assets to go up in value.

Now, even if the real effect of new activity happens due to expectations, the only way to credibly make people expect to higher asset prices is to create a huge number of lottery winners asset owners more wealthy, again and again and again.

This is a natural, unavoidable consequence of using monetary policy as our policy tool to create higher levels of NGDP. It’s written in the hard laws of finance and economics.30 years of ever lower interest rates has significant distributional consequences on our society.