Are central banks to blame for rising inequality?

CAMBRIDGE — Judging by the number of times phrases such as “equitable growth” and “the distributional footprint of monetary policy” appear in central bankers’ speeches nowadays, it is clear that monetary policymakers are feeling the heat as concerns about the rise of inequality continue to grow. But is monetary policy to blame for this problem, and is it really the right tool for redistributing income?

Recently, a steady stream of commentaries has pointed to central-bank policy as a major driver of inequality. The logic, simply put, is that hyper-low interest rates have been relentlessly pushing up the prices of stocks, houses, fine art, yachts and just about everything else. The well-off, and especially the ultra-rich, thus benefit disproportionately.

This argument may seem compelling at first glance. But on deeper reflection, it does not hold up.

Inflation in advanced economies has been extremely low over the past decade, although it accelerated to 5.4 per cent in the United States in June. When monetary policy is the main force pushing down interest rates, inflation will eventually rise. But, in recent times, the main factors causing interest rates to trend downward include aging populations, low productivity growth, rising inequality and a lingering fear that we live in an era where crises are more frequent. The latter, in particular, puts apremium on “safe debt” that will pay even in a global recession.

True, the US Federal Reserve (or any central bank) could impulsively start increasing policy rates. This would “help” address wealth inequality by wreaking havoc on the stock market. If the Fed persisted with this approach, however, there would almost certainly be a huge recession, causing high unemployment among low-income workers. And the middle class could see the value of their homes or pension funds fall sharply.

Furthermore, the dollar’s global dominance makes emerging markets and developing countries extremely vulnerable to rising dollar interest rates, especially with the COVID-19 pandemic still raging. While the top 1 per cent in advanced economies would lose money as one country after another was pushed to the brink of default, hundreds of millions of people in poor and lower-middle-income economies would suffer much more.

Many rich-country progressives, it seems, have little time for worrying about the 66 per cent of the world’s population that lives outside the advanced economies and China. In fact, the same criticism applies to the burgeoning academic literature on monetary policy and inequality. Much of it is based on US data and gives no thought to anyone outside America.

Still, it is useful to try to understand how, under different assumptions and circumstances, monetary policy might affect the distribution of wealth and income. It is possible that, as artificial intelligence advances and monetary policy becomes much more sophisticated, economists will find better metrics than employment to judge the stabilisation properties of monetary policy. That would be a good thing.

Even today, central banks’ regulatory role means that they can certainly help at the margins in addressing inequality. In many countries, including Japan, banks are essentially required to provide very low-cost or free basic accounts to most low-income citizens. Oddly, this is not the case in the US, although the problem could be elegantly solved if and when the Fed issues a central.

But interest-rate adjustments are far too blunt a tool for conventional monetary policy to play any kind of leading role in mitigating inequality. Fiscal policy, including taxes, transfers and targeted government spending, is far more effective and robust.

One popular solution to the problem of wealth inequality, notably advocated by economists Emmanuel Saez and Gabriel Zucman of the University of California, Berkeley, is a wealth tax. But although far from a crazy idea, it is difficult to implement fairly and does not have a great track record across advanced economies. Arguably, there are simpler approaches, such as reforming the estate tax and raising capital-gains taxes, that could achieve the same end.

Another idea would be to shift to a system of progressive consumption taxes, a more sophisticated version of a value-added or sales tax that would hit wealth holders when they go to spend their money. And a carbon tax would raise huge revenues that could be redirected towards low- and lower-middle-income households.

Some might argue that political paralysis means none of these redistributive proposals are advancing fast enough, and that central banks need to step into the gap if inequality is to be tamed. This view seems to forget that although central banks have a certain degree of operating independence, they are not empowered to take over fiscal policy decision-making from legislatures.

As extreme poverty has declined in many countries in recent decades, inequality has become the leading societal challenge. But the view that a central bank’s interest-rate policy can and should be the main driving force behind greater income equality is stupefyingly naive, no matter how often it is stated. Central banks can do more to address the inequality problem, particularly through regulatory policy, but they cannot do everything. And please, let’s stop ignoring the other two-thirds of humanity in this crucial debate.

Kenneth Rogoff, professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. He is co-author of “This Time is Different: Eight Centuries of Financial Folly” and author of “The Curse of Cash”.