September 18, 2014
Charles Lane has a column in the Washington Post arguing that the Fed has contributed to inequality with its low interest policy. Essentially the argument is that low interest rates have helped to push up asset values, most importantly stock prices. Since the rich have stock and most people don’t, this means the rich are getting richer relative to everyone else. Since a lot of people who should know better have made this argument, it is worth addressing.
First, it is important to understand the nature of the inequality. If we’re looking at wealth, the issue is pretty clear. Higher stock prices mean people who own stock are wealthier relative to the population as a whole. (Remember this when you hear reporters tell you the good news that the stock market is up.)
But note the nature of the increase implied here. Grabbing our old “other things equal,” lower interest rates mean higher stock prices. However, this also means that higher interest rates will mean lower stock prices. Most people expect that at some point interest rates will rise due to a strengthening economy. (Many economists want the Fed to raise interest rates now.) So we can expect the wealth inequality the Fed has created with its low interest rate and quantitative easing policies to go away once the economy is approaching its potential level of output.
In that case we are looking at an explicitly temporary increase in inequality. Should we be upset by this?
The situation is even more striking if we look at income. If we count the capital gains in the stock market as income, then we have seen a huge increase in income inequality as stock prices roared back from their 2009 lows. Here also part of this will be reversed as the rich have capital losses when interest rates go back up. (Some of the increase is just a reversal of a market that was depressed due to fears of economic collapse.)
It’s difficult to see the big problem here. Remember, the economy’s problem is too little demand. Let’s say that a few more times just in case anyone in a policy position in Washington is paying attention. The economy’s problem is too little demand. The economy’s problem is too little demand. The economy’s problem is too little demand.
This means that anything that helps to generate demand will increase output and employment. The additional spending due to the stock wealth effect will help to create demand, thereby increasing output and employment. Of course this is not the only way that low interest rates increase demand. Tens of millions of people have refinanced their mortgages. Lower mortgage payments allowed them to increase spending. Lower interest rates also freed up money on interest payments for state and local government. Lower rates also provide some spur to car buying and investment.
And lower interest rates will also put downward pressure on the value of the dollar relative to other currencies. This makes our goods and services more competitive in international markets, thereby reducing our trade deficit.
For all these reasons the Fed policy helped to boost demand and employment. This is improving the situation of middle class and low income people both since it is giving them jobs and also increasing their bargaining power. The latter makes it possible for workers to get their share of the gains from growth.
It is certainly reasonable to say that the Fed’s low interest rate policy is not the best way to get back to full employment. It would have been great if the government had devoted large sums to improving the infrastructure, to retrofitting homes and businesses to make them more energy efficient, to supporting mass transit (can anyone say “free bus travel?”), education, child care, and all sorts of other good things.
Alternatively, since public policy is controlled by deficit cultists who maintain a bizarre fear of government deficits and Martians, we could have prioritized lowering the value of the dollar against other currencies in order to reduce our trade deficit. This means that instead of leaning on China, Vietnam and the rest to pay money to Pfizer for its patents and Microsoft for its copyrights, we ask them to raise the value of their currency against the dollar.
But hey, no one expects the health of the economy to win out over drug company profits, so there is always the path of reducing work weeks and work years through mechanisms such as work sharing and mandated vacations, sick leave, parental leave, etc. That is the key to Germany’s low unemployment rate.
All of these routes might have been better than the Fed’s low interest rate policy as a way to boost employment, but we didn’t do any of these alternative paths. So the choice was having the Fed lower interest rates and have a temporary increase in rich people’s wealth or have higher unemployment. That looks like pretty much of a no-brainer to me.
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