A case of distribution
The widening gap between the richest and poorest members of society is usually attributed to technological change, demographics, immigration, social factors or globalisation. Less attention has been paid to the role played by central banks. Yet the policy of low interest rates, both before and after the financial crisis, has had profound consequences in the distribution of spoils among the rich and the poor.
On a macroeconomic level, monetary policy has depressed household incomes and boosted corporate profit. Low rates have inflated the wealth of the “haves” relative to the “have-nots”. In recent years, cheap money also appears to have discouraged corporate investment and encouraged financial engineering, which has fattened corporate pay packets but stunted future wage growth. To cap it all, low rates have discouraged saving and reduced returns on investment, further shrinking the nest eggs of an increasingly disgruntled middle class.
Central bankers justify easy monetary policy on the grounds that it helps stave off deflation. One of the well-known consequences of falling prices is that corporate profit becomes depressed. This happens because wages tend to fall more slowly than other prices. By the same token, mild deflation boosts the purchasing power of incomes. This is not a new observation. During the 1880s, the Cambridge University economist Alfred Marshall noted that a fall in the price level “tends almost imperceptibly to establish a higher standard of living among the working classes, and to diminish the inequalities of wealth”.
Modern monetary policy works in the opposite direction. By arresting the tendency towards falling prices – arguably a natural consequence of globalisation and new technology – low interest rates have boosted corporate profit and depressed real incomes. In recent years, U.S. corporate profit as a share of national income has climbed to a level last witnessed around 1929. Wage growth in most developed economies has lagged productivity for many years. A recent paper from the McKinsey Global Institute entitled “Poorer than their parents? A new perspective on income inequality” finds that over the past decade around two-thirds of households in advanced economies, comprising over 500 million people, have seen their real incomes flat-line or shrink.
Various studies have pointed out that quantitative easing and other unorthodox monetary policies implemented since the financial crisis have exacerbated wealth inequality. U.S. household wealth recently climbed to record levels relative to GDP. The owners of financial assets and real estate have benefitted disproportionately from this wealth explosion. The same effect is to be found in other countries. In the UK, the top 10 percent of the population now owns nearly two-thirds of financial assets, a sizeable increase since before the crisis, according to S&P Capital IQ. Over the same period, the wealth share of the poorest sections of British society has shrunk.
The increasingly unequal distribution of wealth across developed economies is in part the consequence of central-bank actions deliberately intended to inflate asset prices (through what, in central-bank speak, is called the “portfolio rebalancing channel”). After the crisis, monetary policymakers hoped that higher levels of wealth would encourage spending and investment.
As it turns out, low interest rates haven’t spurred corporate investment as much as expected. Companies have held back on capital spending because they fear, understandably, that the era of extraordinary monetary policy may have a nasty outcome. Why invest when the future is so uncertain? Furthermore, very low interest rates have kept inefficient companies afloat, creating a business environment which is hardly conducive to corporate investment.
Had investment in the United States and elsewhere been higher, then productivity growth and workers’ incomes might have been expected to rise over time. Instead, companies have opted for stock buybacks over capital investment. Profit has been boosted by cutting costs. Record levels of repurchases by U.S. companies have driven up share prices, enhancing stock-based compensation for senior executives and benefitting investors, but providing no tangible benefits for the majority who own few if any shares.
Over recent decades, easy money from the Federal Reserve has created one asset-price bubble after another. Households have been misled by these successive inflations of paper wealth into thinking they needn’t save for retirement. American household savings collapsed to a record low in 2005 and since the financial crisis have remained below their long-term average. The result, as Tyler Cowen of George Mason University points out, is that the pot of pension savings owned by the American middle class is now too small to meet retirement needs.
Ultra-low interest rates may have been necessary to stave off a depression after the Lehman Brothers bust. But central bankers clearly underestimated the distributional impact of their actions. They now find themselves caught between a rock and a hard place. They dare not raise interest rates for fear of triggering another mega-downturn. But if they continue pushing interest rates lower, they risk further undermining the social order upon which capitalism ultimately rests.