politics
economics
Is the Fed To blame for inequality in America?
Federal Financial Analytics
Harvard University
0
0
Genesis
Response
Penultimate
Finale
August 17th, 2021
Wealth inequality in the United States is egregious and indeed, the spectacular decline in real (inflation-adjusted) interest rates over the past fifteen years is a major culprit. Measured by ten-year inflation indexed US treasuries, real rates have fallen by almost 3½ percent since January 2007. This has dramatically elevated the price of equities, housing, fine art, and other long-lived assets.
But the sharp drop in real interest rates is mainly due to global factors including aging populations, slowing productivity and, above all, a dramatic reassessment of macroeconomic risks after the financial crisis and the pandemic. True, if the Federal Reserve had tried harder to resist these global fundamentals, stock prices would probably be much lower and most people would have less wealth, especially the rich. But in all likelihood, higher Federal Reserve policy interest rates would have come at the cost of severely exacerbating unemployment and income inequality.
Of course, the Federal Reserve does have other levers besides interest rate policy. For example, when the Fed issues bank reserves (a form of short-term debt) to buy long-term Treasuries, it shortens the overall maturity of government debt in private hands. This does have some modest impact, albeit far less than it does through its interest rate policies. However, when it comes to the maturity structure of government debt, the Fed is very much a junior partner to the Treasury, whose weekly decisions about whether to borrow long-term or short-term swamp what the Fed is doing over the course of any given year.
We should not forget about the Fed’s many regulatory hats, which give it powers to enhance financial market competition, discourage discrimination, and even promote green growth. However, the central bank's independence from the rest of the government is far weaker and more ephemeral in these areas, where there are many competing agencies (e.g., the EPA) and political interests. If the Federal Reserve were to make regulatory decisions that consistently undercut the will of the Congress, it would find its powers sharply circumscribed, its decisions reversed.
So, if wealth inequality is such a huge problem, and the Federal Reserve’s tools are limited, what can be done? Some have advocated a wealth tax. It is not crazy, but international experience suggests it would be hard to implement and might not end up raising that much money. On the other hand, it would be relatively straightforward to raise inheritance taxes on larger estates, and to plug the myriad holes in the system. A progressive consumption tax, which can easily be implemented in much the same way as today’s income taxes, might not be as viscerally satisfying as a wealth tax, but would be much more effective in reducing consumption inequality, which is ultimately the thing we should care most about.
I very much agree that implementing change is extremely challenging in a political system where big money buys big influence. Whether there is much the Federal Reserve can do here, besides steer as far clear of politics as it can, is questionable.
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