Monetary policy is a necessary tool for correcting business cycle downturns and boosting employment, but despite its importance in fostering growth, monetary policy frequently widens inequality. For those readers who typically associate economics with masochism, under the program of Quantitative Easing, the Federal Reserve makes a monthly purchase of $85 billion in bonds and securities.
Through QE, the Fed stimulates asset markets, such as the stock market. The link between Fed policy and stock market prices was seen in June. The Fed hinted at slowing down QE in the near future and the S&P, a commonly used stock market index, responded by falling nearly 6 percent, according to Bloomberg.com.
Economic theory posits that, through the wealth effect, a rise in these asset prices will cause people to go out and spend more money because the increased value of their investment portfolio makes them feel richer. On paper this sounds awesome; you get rich and celebrate by making it rain, leading businesses to hire more workers who subsequently use their paychecks to make it rain.
But how often has your housemate walked through the door with a bottle of Grey Goose, instead of the usual plastic handle of Odesse, because of a late-day market rally? I will venture to say never.
If you are not one of America’s wealthiest, you probably have not even noticed the improved performance of asset markets because the benefits of inflated asset prices are asymmetrically reaped. The wealthiest 10 percent of Americans own 81 to 94 percent of the nation’s stocks, bonds, trust funds and business equities, according to G. William Domhoff, professor of sociology at the University of California, Santa Cruz.
Trickle-down advocates see the rebound in stock prices as a tide that raises all boats. But, according to a June Pew Center Report, during the recovery, the wealth of the richest 7 percent of households climbed by 28 percent on average, while the rest of the population lost 4 percent of its wealth.
It is true that the entirety of this divergence in wealth is not solely caused by monetary policy, but the St. Louis Fed found that 62 percent of the wealth recovery through the end of 2012 has been the result of rising stock markets. This means that, indirectly, the Fed is at the heart of the wealth divergence problem.
This augmentation of existing inequality, along with being socially undesirable, leads to the reduced efficacy of current and future monetary policy. As inequity increases, financial assets become more highly concentrated in the hands of the fewer and the richer. The smaller the proportion of Americans owning financial assets, the less rising asset value will be linked to increases in consumption.
Think of it this way: If you make Warren Buffett richer, he would still consume the same amount of goods and services. But if America’s poorest were made even slightly wealthier, you would immediately have consumption spending and its multiplied effect injected into the economy.
The reduced potency of monetary policy will only get worse. As we have seen, the richest regained their wealth at a faster rate than the rest of the population during the recovery. Thus, asset ownership becomes increasingly concentrated among the wealthy, diminishing the Fed’s future ability to strengthen consumption and leading to slower and more painful recoveries.
The solution is not to tighten monetary conditions; this will only harm the fragile labor market. Rather, the stabilization of QE’s redistributive tendencies requires incisive fiscal policy, aimed at keeping the wealth gap from spreading during economic recoveries.