How Central Banks Have Made Wealth Inequality Worse
Central banks' attempts to kick-start advanced economies following the financial crisis have made the gap between the rich and poor wider, suggests the Bank for International Settlements.
In the BIS' Quarterly Review, Analysts Dietrich Domanski, Michela Scatigna, and Anna Zabai studied the evolution of wealth inequality in France, Germany, Italy, Spain, the U.K. and the U.S. was influenced by monetary policy since the recession.
On its face, this conclusion may be intuitive: the collapse in financial markets disproportionately hurt households in which financial assets make up a greater portion of their net worth (which tend to be the richest ones). To the extent that central banks aided a reflation in financial assets, they contributed to a dynamic in which wealthier households became richer than less affluent ones. Yet conventional economic wisdom holds that the net effect of central banks on wealth inequality is neutral, the BIS explains.
"Notwithstanding the range of channels through which monetary policy may affect the distribution of wealth, the traditional view holds that such effects are small," the authors write. "As a by-product of the pursuit of macroeconomic stabilization objectives, they net out over the business cycle."
But this time might be different: The length and nature of the stimulus provided by central banks suggest that distributional effects of monetary accommodation have been particularly acute during this cycle.
One of the key transmission channels through which quantitative easing is thought to buoy real economic activity is through the wealth effect: as owners of assets see valuations rise, they feel wealthier and increase spending.
With monetary policy across developed nations remaining stimulative more than seven years after Lehman Brothers filed for bankruptcy, the marginal benefit that accrues to owners of financial assets has persisted for an especially long time.
"All asset classes—houses, stocks, toll bridges, commercial real estate—should trade at higher multiples to cash ﬂows in an era of low interest rates," wrote CIBC World Markets Chief Economist Avery Shenfeld.
The BIS' trio also theorizes that the monetary stimulus' impact on wealth inequality has been enhanced in light of changes to households' balance sheets.
"Households may have become more sensitive to changes in interest rates and asset values over the past decade," they wrote. For one, household balance sheets in advanced economies have expanded much faster than GDP, with total household assets and net wealth growing in tandem. In addition, the share of capital income has been rising steadily since the 1980s and now accounts for about 30 percent of household income in advanced economies."
The primary conclusion from the analysts' report is that "monetary policy may have added to inequality to the extent that it has boosted equity prices."
"Since 2010, high equity returns have been the main driver of faster growth of net wealth at the top of the distribution," they wrote.
Central bank asset purchases designed to push investors further out the risk spectrum have fostered a decline in the equity risk premium, which is positive for stocks.
Increases in home prices tend to serve as a moderating force on wealth inequality, as poorer households have a higher portion of their assets in real estate than the rich.
But no central bank has a mandate to target wealth inequality; indeed, while monetary policy may be exacerbating inequality, it's an ill-fitting tool to directly reduce it.
"The main contribution that the Fed can make to inequality, given that we don't have policies that target particular groups in the labor force, the main contribution we can make is to make sure that the labor market is performing well, that we attain Congress' maximum employment objective," Federal Reserve Chair Janet Yellen said during her semi-annual testimony before Congress.
Trends in financial markets, however, undoubtedly factor into monetary policymakers' decision-making process. For instance, the Federal Reserve indicated that financial market turmoil was a reason to refrain from raising rates in September.
But declines in stock prices disproportionately hurt the wealthiest individuals—ones who have a lower propensity to consume any extra dollar they receive.
If anything, the BIS' analysis may imply that if monetary policymakers want to help reduce wealth inequality, they ought to actively lean against the notion of a 'central bank put'—or the idea that a decline in equity prices to a certain level would inevitably trigger an accommodative response.
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