After 2010 and up to March of 2020, Federal Reserve monetary and regulatory policy helped to make the richest Americans even wealthier and resulting inequality even worse far faster than ever before. After last March, the Fed doubled down on its policy of ultra-low rates, a huge portfolio and ironclad safety nets beneath even the most speculative financial markets. Once fiscal stimulus runs its course, financial policy will make the inequality exacerbated first by the Fed and then the pandemic still worse, faster. This is a recipe for slow growth, increased financial risk and an even angrier electorate.
Averages don’t tell all
Starting in 2016, the Fed said the U.S. economy was in a “good place.” Indeed, one of its top officials called the U.S. an economic “good place” even after COVID threw millions out of work. Put simply, the Fed saw a good place because it looked at Park Avenue.
In recent remarks, the Fed has acknowledged this at least with regard to its unemployment data. The Fed has also begun to publish the Distributional Financial Accounts of the U.S., a trove of data, including the fact that, for the first time, the top one percent had more wealth than the bottom fifty percent in 2019. Unfortunately, as charts the Fed uses to craft monetary policy showed as recently as March 17, the Fed has consigned distributional thinking to economists and kept policy-making on the course set by data that masks the depth of income and wealth inequity, inequality and just plain inadequacy across the nation as a whole.
Beyond good data to equitable policy
The Fed may well concede the point about what economists call “representative-agent” data — which is an economic model where “agents act in such a manner that their cumulative actions might as well be the actions of one agent maximizing its expected utility function” — and adopt a more “heterogeneous” or distributional approach. That’s an important first step to equitable monetary policy, but it’s not enough. A truly “good” economic place requires the Fed to take responsibility for its inequality effect, not just toss the responsibility for economic equality off to Congress and whatever administration is in charge.
After all, economic inequality is at its root a financial condition resulting from income and wealth disparities — and what are income and wealth if not money? A central bank that drives money flows is thus indisputably an agent of equality or inequality as it so chooses and as broader national tax, trade, and social policies allow.
Further, the Fed’s statutory mandate expressly directs it to focus not just on aggregate, average definitions of “maximum” employment and inflation, but on shared prosperity. Starting in 1946 and through to its current mandate, the Fed is directed to pursue “full” employment as measured by labor force participation, inflation as measured by the cost of being middle class and — a little-know third requirement — to set interest rates at a “moderate” (not ultra-low) level to make it possible for middle-class Americans to save for the future.
Still, ever since 2010, the Fed did three things that make American less economically equal: set ultra-low interest rates, hold a huge portfolio and spread a safety net beneath financial markets. This might have made sense if it resulted in robust growth even as measured by GDP — another average that hides enormous inequality — but even GDP growth was the weakest since the Second World War.
At the same time, as financial markets did just fine, income inequality widened and wealth inequality grew the fastest since the Roaring 20s. From 2007 through 2019, U.S. stock market investors saw a 77 percent gain; small savers eked out tiny interest rates often eviscerated by fees, resulting in negative real rates of return — making it impossible to accumulate wealth via saving for a down payment, a child’s education, or secure retirement. The enormous gulf between seemingly-inexorable stock market increases and grave un- and under-employment make this all too clear. The Fed has done far more for capitalists than capitalism.
2021 and beyond
Since March of 2020, the Fed doubled down on its post-2010 policy, driving short-term rates still lower, hugely expanding its portfolio and spreading an even more impermeable safety net beneath financial markets. Even so, the Fed refuses to normalize its policy despite the fact that it projects awesome improvements in U.S. economic growth through the second half of 2021, COVID willing. The Fed rationalizes its ultra-loose policy on forecasts showing that the Fed’s forecast thereafter is glum. This is all too accurate — without normalized financial policy, the U.S. cannot have normalized economic growth because it will be even more unequal than it was in March of 2020 (when it was already record-breaking).
The Fed has begun to recognize — if not yet to act on — the fact that acute economic inequality frustrates not just shared prosperity, but also overall economic growth. Economic inequality does fine by financial markets, but that’s only until they crash. Look at 2008, 2020 and research showing that inequality is perhaps the most predictable cause of financial crises.
Still, it inexorably pursues the same policies that, ever since 2010, did little but set the stage for the next financial crisis, a fragile economy and a furious electorate sick and tired — as well it might be — of seeing hope for shared prosperity grow ever more fleeting.
Karen Petrou is managing partner at Federal Financial Analytics and the author of Engine of Inequality: The Fed and the Future of Wealth in America.