Photo: AFP
Photo: AFP

Can monetary policy increase inequality?

Increase in money supply is likely to benefit those who are more connected to financial markets

Does the power of central banks to control supply of money and influence its cost have an impact on distribution of income and wealth? The interest rate in a number of advanced economies has remained near zero since the financial crisis of 2008, and central banks have been pursuing unconventional monetary policy. Even though the US Federal Reserve raised interest rates late last year, other central banks such as the European Central Bank and Bank of Japan have now pushed interest rates into negative territory.

One of the objectives of the unconventional monetary policy has been to push asset prices up, in order to create the so-called wealth effect which is expected to boost consumption and economic activity. Since rich households own more assets, especially financial, it is often argued that only they benefit from such policies. Therefore, questions are now being raised if monetary policy in advanced economies are actually pushing inequality. To be sure, economists have been debating the unintended consequences of changes in monetary policy, including its effect on inequality, for some time. The latest quarterly report of the Bank for International Settlements (BIS) has also explored the issue.

It said that the rise in share prices is the key driver of inequality and bond prices have had a negligible impact. But how does monetary policy affect income and wealth distribution? A 2012 National Bureau of Economic Research (NBER) paper, Innocent Bystanders? Monetary Policy and Inequality in the US, highlighted several avenues such as income composition, financial segmentation and portfolio channel through which monetary policy can affect income and consumption inequality.

For instance, if expansionary monetary policy leads to higher growth in profits than wages, income for those with ownership of businesses will rise faster than people dependent on wages. Similarly, increase in money supply is likely to benefit those who are more connected to financial markets. Rich households with their holdings in financial assets would fall in this category. Therefore, the argument that higher asset prices due to expansionary monetary policy is benefiting the rich and is leading to higher inequality might seem convincing to many.

However, the issue is far more complicated and there are probably no clear answers. The NBER paper quoted above, which studied monetary policy shocks on income and consumptions inequity in the US since 1980, noted that contractionary monetary policy increase inequality. “Contractionary monetary policy shocks appear to have significant long-run effects on inequality, leading to higher levels of income, labour earnings, consumption and total expenditures inequality across households," the paper said. Also see

Ben Bernanke, former chairman of the Federal Reserve, in an article in 2015, answered some of the criticism of unconventional monetary policy and its perceived role in fuelling inequality.

Bernanke argued that inequality is a long-term trend and is the result of a number of structural changes occurring in the economy over decades—the role of monetary policy is transient and modest. More importantly, Bernanke noted: “Most economists would agree that monetary policy is ‘neutral’ or nearly so in the longer term, meaning that it has limited long-term effects on ‘real’ outcomes like the distribution of income and wealth." He also argued that further research in this area would be required as the effect of monetary policy on distribution is not very clear. The BIS paper also advocated the same.

At a broader level, monetary policy, especially in advanced economies such as the US, is driven by defined objectives and policy makers are not necessarily worried about unintended consequences, both in the domestic economy and the rest of the world. The aggressive use of unconventional monetary policy, for instance, has resulted in accumulation of debt stock in several developing and emerging market economies and is a risk to financial stability in case of sharp reversal.

Will central banks in advanced economies be willing to consider potential side effects in policy making? A lot will depend on how policy debates evolve in times to come.

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