The Fed's Easy-Money Policies Aren't Helping Income Growth
Back in August, Bloomberg interviewed Karen Petrou about her research on quantitative easing and the Fed's policies since the 2008 financial crisis. What she has discovered has not been encouraging for people who aren't already high-income, and in recent research presented to the New York Fed, she concluded "Post-crisis monetary and regulatory policy had an unintended but nonetheless dramatic impact on the income and wealth divides.”
This assessment is based on her own work, but also on a 2018 report released by the Minneapolis Fed.1 The report showed that both income and wealth growth in the US have been much better for higher-income households in recent decades
Notably, when indexed to 1971 (the year Nixon ended the last link between gold and the dollar) we can see the disparity between the top wealth groups and other groups:
What did we learn [from the Minneapolis Fed report]? This new dataset shows clearly that U.S. wealth inequality is the worst it has been throughout the entire U.S. post-war period. We also know now that the U.S. middle class is even more “hollowed out” than we thought in terms of income, with any gains made by the lower-middle class sharply reversed after 2007.
Indeed, the report concludes: "...half of all American households have less wealth today in real terms than the median household had in 1970."
A closer look at income data also suggests that income growth has been especially anemic since 2007. Using data from the Census Bureau's 2017 report on income and poverty, we find that incomes for the 90th percentile are increasingly pulling away from both the median (50th percentile) income and from the 20th-percentile income.2
The household income for the 90th percentile increased 70 percent since 1971, while it has only increased 20 percent at the 20th percentile.
Of course, we might think, "we should be happy that the 20th-percentile income went up by 20 percent!" True enough, but as we can see by merely eyeballing the graph, most of that income growth at the lower income levels occurred before the year 2000. Incomes haven't moved much since then.
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Indeed, since the year 2000, income increased 12 percent for the 90th percentile, but only 2.4 percent for the median household. It declined 3.7 percent at the 20th percentile
Moreover, Petrou notes,
the latest census data show that U.S. median household income in 2016 rose in part because more families have more wage-earners. Two low-wage jobs may seem like more employment, but they are reflecting the ever-greater struggle lower-income Americans have making ends meet.
Similarly, the overall wealth data offers little to get excited about. As noted here at mises.org last month, median wealth in the US is still well below the peak levels pre-2007.
That's according to Edward Wolff's 2007 report. According to the Fed's 2017 survey on consumer finances, median wealth reached $97,300, which is still down from 2007's level of $139,700. Those in the 90th percentile experienced much more growth in wealth, with an increase from $1,054,000 in 2007 to $1,186,000 in 2016.3
What Role Does the Fed Have in All of This?
As the Federal Reserve has become more interventionist, more inflationary, and more prone to regulate the private sector, incomes have stagnated. For example, gaps in wealth and income have been growing since the 1980s, but they worsen significantly over the past decade as monetary policy became more and more inflationary and activist.
It’s common knowledge that income inequality in the U.S. has been getting increasingly worse since 1980. But what I’ve been pointing out in some of my blog posts is that it became hugely worse after the financial crisis. Were there underlying issues pre-2008? Absolutely. But we had more of a middle class even in 2006 than we do now. ... [I]f you look at the Minneapolis Fed data, as well as many other analyses, [growth in inequality] happens gradually prior to 2008. Then it actually flattens out in 2008 because rich people lost money in the crash, which narrowed the inequality gap. But starting in 2010, the gap widens dramatically.
The Fed became far more active in its interventions after 2008, leading to a variety of consequences:
The Fed did two things with huge inequality implications. First, with its massive quantitative easing, it sucked $4.5 trillion of assets out of the banking system. The idea was that it would empty out the bank balance sheets so that they would start to make loans. And that didn’t happen —initially the banks were too weak, and as they recovered, the rules created significant impediments. If you look at who is getting loans it is large corporations, not small businesses. Second, the Fed’s low-interest policy gave rise to yield-chasing. And what has the stock market done since 2010? Everybody who has money has seen their financial assets appreciate dramatically. Everybody who doesn’t have money, which is the bottom 90 percent, what is their principal source of wealth? Houses? House-price appreciation for expensive houses is way up since 2012. But overall, real U.S. house prices are down 10 percent.
On the regulatory side, the Fed made it more difficult for banks to cater to small businesses and other borrowers who are less well-known and higher risk. At the same time, the Fed has made it so that lenders don't have to worry about catering to a broad cross-section of borrowers precisely because the Fed's regulation and its too-big-to-fail doctrine lower the relative opportunity cost of ignoring borrowers at the lower end.
Meanwhile, ultra-low interest rate policy leads to yield-chasing which favors the already-wealthy at the expense of households of more ordinary means. Yield-chasing pulls money out of safer, more conservative investments — favored by people of modest means — and drives more investment toward riskier hard-to-access investment instruments.
Petrou describes some of the effects of yield-chasing:
As our research shows, QE exacerbates inequality because it takes safe assets out of the U.S. financial market, driving investors into equity markets and other financial assets not only to place their funds, but also in search of yields higher than those possible with ultra-low rates. The Fed hoped that soaking up $4.5 trillion in safe assets would stoke lending, and to a limited degree it did. However, new credit largely goes to large companies and other borrowers who have used it for purposes such as margin loans and stock buy-backs, not investment that would support strong employment growth. Growing household indebtedness in the U.S. is principally consumption or high-price housing driven and thus also a cause – not cure – of inequality.
And then there is the problem of asset-price inflation. This contributes to economic inequality in more than one way.
Asset price inflation is largely a result of inflationary monetary policy in which newly created money continually enters the economy. This, in part, increases economic inequality through Cantillon effects. As new money enters the economy, it benefits some people — usually high-income people — more than others. The new money does not enter the economy evenly and equally for everyone, but benefits certain politically-connected firms, institutions, and persons first. These people and organizations can then use the new money before prices in the economy adjust to reflect the new, larger money supply.
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But there's more to asset-price inflation's role in inequality.
As Petrou notes above, "Everybody who has money has seen their financial assets appreciate dramatically." For those who already own sizable amounts of stocks, for instance, there won't be a problem. The same will be true of people who own real estate in fashionable and expensive markets.
Stocks — Not Housing — Are Favored by Post-2008 Inflationary Policy
And here's the rub: moderate- and low-income people tend to have much more of their wealth in residential real estate than in the stock market.
Since 2007, wealth growth in housing has been negative while growth in stock-based wealth has remained positive:
The overall effect here has been that higher-income investors, who have less of their wealth in homes — and more in stocks — have benefited more from the asset inflation of the past decade. The effect has been rising inequality.
So we might then ask ourselves: "why don't more moderate- and low-income people just buy more stocks?
Part of this is due to tax incentives, which reward putting money into housing rather than into stocks. Moreover, many people put money into homes rather than stocks because homes have the added perk of providing a place to live.
While it may be prudent — all else being equal — to buy less house while buying more in stocks, the Fed's ultra-low interest-rate policies make housing relatively more attractive as a place to park one's wealth.
And finally, investing in stocks remains something of a perk reserved to those with a surplus. After all, one can rarely elect to simply not spend money on housing. It's easy, though, to just not buy stocks. In most cases, money must be spent on housing in some form. And many elect to purchase housing, since, in many cases, houses are often perceived — often with good reason — as a fairly safe and stable investment.
If we then add to this many deliberate efforts by both the Fed and the federal government to increase the homeownership rate, it's not hard to see why so many have ended up with a sizable portion of their wealth in housing.
While the central bank certainly can't be blamed for all the factors at play here, it nevertheless plays a significant role. Through a combination of inflationary monetary policy, regulation, and asset purchases, the Fed has made a sizable contribution to an economy that favors certain types of investments, certain institutions, and certain purchasing patterns.4 Fed policy now favors high-income earners and investors over low- or moderate- income earners and investors. The result has been a rapidly widening wealth and income gap over the past decade.
- 1. "Income and Wealth Inequality in America, 1949-2016" by Moritz Kuhn. Institute Working Paper 9, June 2018.
- 2. "Income and Poverty in the United States": 2017, Current Population Reports. Released September 2018.
- 3. "Changes in U.S. Family Finances from 2013 to 2016: Evidence from the Survey of Consumer Finances." Federal Reserve Bulletin. September 2017 Vol. 103, No. 3
- 4. Inflationary policy became especially expansive after 1971 when Nixon closed the gold window. Indeed, it is likely not a coincidence that the Minneapolis Fed report shows that inequality (as expressed in income shares) was quite stable from 1950 to 1970. After 1971, inequality increasese more rapidly. See page vi of appendix: https://www.minneapolisfed.org/institute/working-papers-institute/iwp9.pdf