Monetary Policy and Inequality

Summary

The majority of the CfM panel of experts on the UK economy thinks monetary policy has only a small impact on wealth and income inequality. A larger majority of nearly 90% of the panel believes that inequality should play a minimal role or no role in the Bank of England’s monetary policy decisions.

Background

The July 2021 CfM survey asked the members of its UK panel to evaluate the impact of central banks on inequality and whether the Bank of England should consider income and wealth distribution in its monetary policy decisions. 

The Bank of England and Inequality

By most measures, income inequality has increased in the UK in the past several decades. The Bank of England’s remit is for price stability, with no mention of inequality or distributional implications in the 2021 update. Recent academic research has paid more attention to the effect of monetary policy on inequality and some have called for a greater role for distributional considerations in monetary policymaking.

The academic literature on monetary policy and inequality is still in its infancy and is split on whether looser monetary policy increases or decreases income inequality. Using survey data Mumtaz and Theophilopoulou (2017) show that looser monetary policy decreases inequality in labour earnings, consumption, and expenditures in the UK; Coibion et al (2017) report similar findings for the US. Considering the racial dimension, Bartscher (2021) show that looser monetary policy increases the income and employment rate of black households relative to white.

Cloyne, Ferreira, and Surico (2020) argue it is the consumption of mortgagors that increases the most when interest rates decline, in a study of UK households. This implies that loose monetary policy improves the lot of middle-income households the most (an “inverted-U-shape” response of consumption to lower interest rates along the income distribution). Albert and Gómez-Fernández come the exact opposite conclusion, showing simulations that predict that the income and wealth of the poorest and wealthiest increase the most when monetary policy is loose.

Amberg et al (2021) report similar findings using Swedish administrative data, with the richest and poorest households benefiting the most from low interest rates. In contrast, Andersen et al (2021) investigate the wealth of Danish households, also using administrative data, and find a monotonic relationship whereby lower interest rates increase wealth and total income more the wealthier is the household to begin with. Further studies on this topic can be found in a conference organized by the Bank of England and the Centre for Macroeconomics on the topic of inequality and monetary policy.

Several channels have been suggested for the effects of monetary policy on inequality. First is the employment channel whereby lower income households are more likely to lose jobs in recessions, while looser monetary policy increases employment (Draghi, 2016). Second is the asset price channel. Richer households hold riskier and more cyclical assets and benefit more from looser monetary policy (Bernanke, 2015). This is the channel implied in the study of Andersen at al (2021), while Cloyne, Ferreira, and Surico (2020) rely on debt deflation of levered mortgagors. Doepke and Schneider (2006) point to a similar channel.

Policymakers have taken heed and have begun considering the implications of monetary policy for inequality. The annual report of the Bank of International Settlements discusses this topic but concludes that monetary policy has had only a small impact on inequality and can do little to reverse the broader forces that have caused increases in wealth and income inequality. (See also Martin Wolf’s FT article.) In a 2014 speech, Andy Haldane, then a member of the Financial Policy Committee of the Bank of England states that there is little that a central bank can do to combat income inequality but that inequality does affect the policies a central bank will need to conduct to ensure price and financial stability. Feiveson et al. (2020) suggest that central banks can do more (or less harm) for income inequality if they followed “average inflation targeting” strategies rather than maximum inflation targeting as in the case of the European Central Bank. The European Central Bank itself has analysed the effects of its policies on income distribution and evaluates that quantitative easing has reduced inequality (and regional inequality) through the employment channel. Turning from income to wealth, the Resolution Foundation finds that quantitative easing in the UK has exacerbated wealth inequality, through the asset price channel.  The House of Lords has called for more research on this topic, but argues that it is the role of fiscal policy rather than monetary policy to counteract the distributional implications of quantitative easing policies.

This month’s CfM survey asks about the monetary policy and inequality. The first question asks whether monetary policy has a “large” impact on the distribution of income and wealth over the business cycle or in the long run. In evaluating whether the effect is “large,” consider whether it is large enough to potential require corrective policy either by the Bank of England itself or through other policy tools (e.g. fiscal policy). When evaluating the magnitude of the impact consider monetary policy shifts that are of the magnitudes observed in the typical conduct of the Bank of England, in its attempts to meet its inflation objectives. You are not being asked whether looser monetary policy increases or decreases inequality but may choose to discuss this in your comments.

Question 1: How large is the impact of monetary policy on the joint distribution of income and wealth?

Twenty-eight panel members responded to this question. A slight majority views the impact of monetary policy on inequality as being small (46% of respondents) or very small (7% of respondents). A smaller share sees the impact as being large (39%) with the remainder (7%) expressing no opinion.

Panelists who think monetary policy has only a small effect on equality believe that other factors determine the distribution of income and wealth in the long run. Jagjit Chadha (National Institute for Social and Economic Research) writes that in the long run “real income [and] wealth… are determined by tastes and technology.” David Cobham (Heriot Watt University) points to political determinants of inequality in stating that “the sources of the growing inequality of recent decades—a failure of and a stain upon democratic society and capitalist economy—lie elsewhere, in the increased imbalance of power in the labour market resulting mainly from changes in industrial structure, the suppression of trade unions and the perceived lack of any alternative economic/social model.”  

The small impact of monetary policy on inequality is also because it is a cyclical tool that has only minor permanent effects on the real economy. Charles Bean (London School of Economics) notes that “central banks are setting policy so as to keep output near potential and inflation at target. So it is wrong to think of monetary policy as an independent influence on inequality. It is instead the necessary reflection of all the other factors that affect demand and supply in the economy (i.e. the determinants of 'r*', the equilibrium real rate of interest).”

The effects of monetary policy on inequality changes over time and has heterogeneous effects, making it difficult to assess its full distributional implications. Monetary policy also has differing effects on the distribution of wealth and on income, in ways that may cancel out on average. Panicos Demetriades (University of Leicester) explains that “loose monetary policy may well increase employment opportunities which benefit the unemployed and the least well off, [while raising] asset prices,” and thus benefiting the poor and rich in different ways. Charles Bean writes that “the impact is potentially ambiguous and likely to be state-dependent. In particular, looser monetary policy tends to benefit those without jobs as well as benefitting those with assets (and vice versa).” David Miles (Imperial College) adds: “The effects of monetary policy on incomes and wealth come through several different channels… These different effects are partially offsetting and are probably quite different at different points in business cycles. They also affect people of different ages in different ways - something which evens out over a person's life.”

The minority view held that the monetary policy impacts inequality substantially through its effects on asset prices, particularly when quantitative easing is involved. Roger Farmer (Warwick University) summarizes this opinion: “Since both housing wealth and stock market wealth are very unequally distributed, these policy decisions also have large impacts on the wealth distribution.” Morten Ravn (University College London) points to his own research that uncovers equilibrium effects whereby monetary policy “impact[s] interest rate spreads between borrowing and savings rates which affects the extent to which households can self-insure against income shocks.” Finally, Kate Barker (British Coal Staff Superannuation Scheme and University Superannuation Scheme) argues that “good monetary policy” can avoid hysteresis effects and thereby mitigate the long run distributional impacts of recessions.

The panel was next asked whether the Bank of England itself had a role in considering income inequality in its policy decisions.

Question 2: What role should inequality play in the monetary policy decisions (interest rate policy and quantitative easing)?

Twenty-eight members of the panel answered this question. A large majority thinks that distributional implications should have a minimal role (57% of respondents) or no role at all (29% of respondents) in the Bank of England’s policy decisions. Only 14% believes that the inequality should play a substantive role in monetary policy decisions.

The majority view points out that whatever the distributional effects of monetary policy, it is up to fiscal policy and political to address the distribution of income, not the role of a central bank. Charles Bean argues that “distributional issues are at the heart of politics and distributional questions should be decided by politicians not the unelected technocrats who staff central bank policy committees.” Further, “the central bank does not have good tools to deal with inequality; fiscal policy can be more targeted” Michael McMahon writes. He too believes that “it is important that the objectives of redistributive policies reflect the preferences of the electorate,” not that of the monetary policy committee. Roger Farmer worries that “f the Bank becomes involved in highly politicized decisions including, but not limited to, asset purchases designed to redistribute income and wealth, there is a danger of losing the current political consensus for Bank independence.” Costas Milas (University of Liverpool) summarizes the majority view in arguing that we cannot expect the Bank of England to be “Bob the Builder, to fix it all.” It’s main role, Milas argues is to “defend price stability”.   

The minority view nevertheless supports some distributional considerations in monetary policy decisions. “Inequality concerns should be on the table,” argues Morten Ravn, who believes that inequality “should be one of the issues discussed when determining the stance of monetary policy.” Several panel members (David Miles, Wouter den Haan) reject inequality considerations in monetary policy decisions because our state of knowledge on the topic is still in its infancy. In this regard, Wendy Carlin (University College London) calls on central banks to improve their “understanding of the determinants of changes in income and wealth inequality in order to understand better the nature of business and financial cycles, and to learn about how their decisions in line with their existing mandates affect outcomes for inequality.”

References and Further Readings

Albert, J. F., & Gómez-Fernández, N. (2021). Monetary policy and the redistribution of net worth in the US. Journal of Economic Policy Reform, 1-15.

Amberg, N., Jansson, T., Klein, M., & Rogantini Picco, A. (2021). “Five Facts about the Distributional Income Effects of Monetary Policy,” CESifo Working Paper No. 9062.

Andersen, A. L., Johannesen, N., Jørgensen, M., & Peydró, J. L. (2021). “Monetary policy and inequality,” unpublished manuscript.

Bartscher, A. K., Kuhn, M., Schularick, M., & Wachtel, P. (2021). “Monetary policy and racial inequality,” unpublished manuscript

Coibion, O., Gorodnichenko, Y., Kueng, L., & Silvia, J. (2017). Innocent Bystanders? Monetary policy and inequality. Journal of Monetary Economics, 88, 70-89.

James Cloyne, Clodomiro Ferreira, Paolo Surico, Monetary Policy when Households have Debt: New Evidence on the Transmission Mechanism, The Review of Economic Studies, Volume 87, Issue 1, January 2020, Pages 102–129, https://doi.org/10.1093/restud/rdy074

Doepke, M., & Schneider, M. (2006). “Inflation and the redistribution of nominal wealth.” Journal of Political Economy, 114(6), 1069-1097.

Draghi, M. (2016). “Stability, equity and monetary policy.” German Institute for Economic Research (DIW).

Feiveson, L., Gornemann, N., Hotchkiss, J. L., Mertens, K., & Sim, J. (2020). “Distributional considerations for monetary policy strategy,” unpublished manuscript.

de Ferra, Sergio, Kurt Mitman, and Federica Romei, “Household heterogeneity and the transmission of foreign shocks,” Journal of International Economics, Volume 124, 2020.

Mumtaz, H., & Theophilopoulou, A. (2017). “The impact of monetary policy on inequality in the UK. An empirical analysis.” European Economic Review, 98, 410-423.