Holding inequality in reserve

The Federal Reserve on May 21 will release the minutes of the last meeting of the Federal Open Market Committee, the central bank’s policymaking committee. Fed watchers will be looking at the notes to see how Fed officials are thinking about the economy. The minutes are unlikely to contain any big policy actions, but there will be hints about future moves.

As Alan Blinder, a member of the Equitable Growth Steering Committee, points out, the debate about ending the Fed’s extraordinary efforts started during the crisis will heat up in the coming months. The debate between the hawks and the doves will center on inflation and unemployment, but the Fed’s actions also affect another aspect of our economy: income inequality.

The Fed’s mandate requires that it ensure price stability as well as maximum employment. The mandate doesn’t explicitly lay out what level of employment is maximum and how quickly prices have to be rising for them to be unstable, so the central bankers have to interpret their mission as the economy changes. The unemployment rate is currently falling, but the share of the population with a job has barely budged since the labor market bottomed out in 2010. Raising rates and throttling growth before employment is truly “maximum” could condemn millions of workers to permanent unemployment and our economy to a slower rate of economic growth.

That’s why the ongoing debate about the state of the labor market, as technical as it may be, is so vital for the health of our economy.

Not only would a premature tightening create inequality through unemployment, research shows that contractionary monetary policy can increase inequality in income and consumption. A National Bureau of Economic Research working paper by Olivier Coibion, Yuriy Gorodnichenko, Lorenz Kueng, and John Silvia looks at the effect of monetary policy shocks and inequality. They find that these shocks significantly affect income and consumption inequality and that the effect is similar in size to the effect of monetary policy on GDP and inflation.

What should Fed Open Market Committee members make of this research? This apparent inequality effect isn’t solely due to increased unemployment because earnings decline for full-time workers at the bottom of the income distribution, which indicates earnings went down for workers who weren’t thrown out of work. Furthermore, the authors find that earnings actually increase for households at the 90th percentile after monetary policy becomes contractionary, which means the rising inequality wasn’t just due to declining earnings at the bottom.

The Federal Reserve’s mandate says nothing about ensuring a reasonable amount of income inequality while keeping prices stable and employment as high as possible. But the members of the FOMC should consider that they may not be innocent bystanders when it comes to our economy’s high and rising levels of inequality.

May 20, 2014


Monetary Policy

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