In this guest post, Victor Xing of Kekselias looks at how central banks are dealing with the distributional effects of their policies.
While officials have previously acknowledged QE programs’ distributional effects, they had nevertheless expected the aggregate economic benefits of these unconventional policies to outweigh these costs.
Post-crisis asset price appreciation outpaced median wage growth to unintentionally burden low-to-middle income households and individuals with limited asset ownership. Rising inequality in-turn fueled discontent and contributed to the rise of anti-establishment political candidates.
Efforts by elected officials to ease the effects of policy-induced inequality would likely bolster support for redistributionary policies such as “helicopter money”, which could threaten monetary policy independence.
Monetary policies rely on financial markets to affect the real economy. This is at the core of central banks’ focus on financial conditions. Unconventional policies such as quantitative easing (QE) are no exception.
QE works like this:
- Central bank uses newly created digital ledger entries (a.k.a. “money printing”) to buy long-maturity bonds in the open market and push down long-term interest rates (bond yields decline as prices rise)
- Borrowing costs correlated with long-term interest rates (such as mortgage rates and corporate borrowing cost) would decline and incentivize individuals and corporate borrowers to pull forward future expenditure
- By depressing safe haven investment returns (such as Treasury securities), risk adverse investors would be pushed to invest in riskier sectors such stocks, corporate high yield borrowing (credit risk), and real asset (liquidity risk)
In essence, QE facilitates credit easing by encouraging re-leveraging. It utilises a “recruitment channel” to induce market participants to help the monetary authorities depress long-term interest rates and push up risky asset valuations.
Policymakers have acknowledged monetary policies’ distributional effects on several occasions, but such effects are generally tolerated for as long as the overall effects are expected to help achieve policy mandates. Boston Fed President Rosengren highlighted some of these distributional effects during a 2016 Q&A session and explained FOMC’s decision to keep rates low:
There are distributional effects that occur with monetary policy. When we lower interest rates, there are definitely some people worse off. The people that are worse off are people that are saving. But the people that are better off are the people who are borrowing. So take my daughter, who is in medical school, with student loans, and wants to buy a house, wants to buy a car, wants to buy new clothes, and then look at how many houses, cars and new clothes you [savers] are looking to buy.
So you are affected by the fact of low interest rates, but your consumption pattern probably won’t be dramatically affected as her consumption pattern. What that means is that when I am trying to get a good effect for the overall economy, the people who are borrowing tend to do more consumption than the people who are saving. And as a result, lower interest rates do tend to result in a stronger economy than we otherwise would have.
President Rosengren and other policymakers generally projected that wage growth would materialize in due time (although Governor Brainard expressed concerns). Its continued absence amid QE’s success at elevating asset prices began to foster unwanted consequences outside of economic hubs.
Remember that monetary policies that depend on financial markets as a transmission medium inevitably concentrate their effects on asset prices (asset price inflation, with housing costs being one manifestation of this effect). Individuals with limited asset ownership would therefore have to rely on “trickle-down” effects to benefit from QE programs:
- Lower borrowing costs are supposed to encourage consumers and businesses to borrow and spend, motivating other businesses to expand, which should push up hiring and create jobs for asset-less individuals
- “Trickle-down” benefits rely on a sequence of assumptions; as long as the assumptions hold, all are expected to benefit from QE (although entities with assets and capital enjoy far greater benefits than those relying on wage growth)
The biggest assumption is the Phillips curve, which links declines in unemployment with accelerating consumer price inflation via rising wages. Policymakers believed that rising wages from higher employment would help low to middle-income households keep up with policy-induced asset price inflation, thereby keeping and the income and wealth gaps between asset owners and the asset-less in check.
Unfortunately, broad-based wage growth did not materialise, despite large drops in the unemployment rate. St. Louis Fed researchers attributed this to technological improvements and a globalised work force, which dampened demands for middle-skill (and middle-income) jobs that perform routine functions. New York Fed researchers also noted the declines in real median wages amongst low-to-middle skill workers:
Thus, as asset price appreciation become entrenched well ahead of wage growth, those who experienced stagnant pay became further burdened by effects of QE:
- Young workers facing disappointing employment prospects in rural America could not move because rapid rises in housing costs made living near economic hubs unaffordable
- The lack of affordable housing also turned would-be buyers into “involuntary renters” to compete against young renters for affordable housing
Policymakers are taking note of these developments, and Minneapolis Fed President Kashkari recently tweeted a WSJ report highlighting workers outside of economic hubs had little choice but to remain where they were, as (QE induced) asset price appreciation in major metropolitan regions created additional and unexpected barriers of entry.
Inequality issues are generally outside of monetary authorities’ policy purview (although Chair Yellen had outlined her low rates policy in terms of her desire to help middle and lower-income families), for they are largely responsibilities of elected officials and fiscal authorities.
However, social discontent — partly due to the perceived distributional impact of expansionary monetary policy — has already generated political — and hence economic — outcomes in the form of Brexit and rise of anti-establishment movements:
- Dissatisfied voters in regions experiencing economic hardship lost faith in establishment political candidates, for their optimism on the economy did not resonate with voters who continued to experience acute hardship
- Voters in parts of rural America, the working poor inside economic hubs who have trouble scraping together $400 to pay for emergency expenses after housing bills, as well as U.K. pensioners facing lower fixed income returns and higher cost of living had reasons to view establishment policies with skepticism
- With few able to distinguish the roles of elected officials (legislators and fiscal authorities) from monetary officials, the former took the blunt of voter dissatisfaction and became casualties under the wave of populist rebellion
Acknowledging the shift in political tide, U.K. PM May’s remarks in her post-Brexit referendum speech was unsurprising:
Today, too many people in positions of power behave as though they have more in common with international elites than with the people down the road, the people they employ, the people they pass in the street. But if you believe you’re a citizen of the world, you’re a citizen of nowhere. You don’t understand what the very word ‘citizenship’ means.
May also acknowledged QE’s “bad effects” to contradict Bank of England Governor Carney’s effort to keep rates low:
Because while monetary policy – with super-low interest rates and quantitative easing – provided the necessary emergency medicine after the financial crash, we have to acknowledge there have been some bad side effects. People with assets have got richer. People without them have suffered. People with mortgages have found their debts cheaper. People with savings have found themselves poorer. A change has got to come. And we are going to deliver it. Because that’s what a Conservative Government can do.
Once elected officials recognize QE’s distributional effects, which exacerbated inequality amid uneven wage growth, thus fueling populist support toward unconventional political challengers, their well-honed self-preservation instincts would likely redirect the object of voter dissatisfaction toward another convenient target: central bank officials and their “irresponsible monetary adventurism.”
This would offer an effective segue to allow establishment candidates to tap into populist support and morph their candidacy away from traditional partisan issues (which are vulnerable to disruptors) into struggles for those disadvantaged by distributional central bank policies (which were featured prominently in PM May’s speech).
These views can be seen in Jeremy Corbyn’s push toward “People’s QE”, as well as recent discussions over Universal Basic Income via debt monetization, which is based on Milton Friedman’s “Helicopter Money” to bypass the financial sector in the transmission of ultra-accommodative monetary policies, i.e. “channel QE money directly to the people and communities!”
With Corbyn’s “People’s QE”, the Bank of England would print money via digital ledger entries, similar to traditional QE, to either directly buy HM Treasury’s debt issuance, or directly transfer money to Treasury to pay for government expenditure. (Adam Posen, who served on the Monetary Policy Committee of the Bank of England, once suggested something similar.)
Ben Bernanke’s essay on Milton Friedman’s “Helicopter Money” proposal explained how the Fed would print money to pay for increases in Federal expenditure, tax cuts, or purchases of private assets.
Both of these proposals could infringe on central banks’ hard-won monetary policy independence by turning them into on-demand cash machines for fiscal authorities, although both have the support of at least some central bankers. It would be difficult for monetary authorities to terminate debt-financed fiscal expansion after it was set in motion: social pressure would make an exit politically difficult, for opponents to debt monetization would be labeled as “opponents to making QE fair again”.
The subjugation of monetary policy independence could quickly manifest in rapid rise of inflation as seen after the Federal Reserve ceded monetary policy control to the Treasury to fund spending during WWII. Politicians in control of monetary policies might want to maintain reflationary policies longer than necessary and let subsequent administrations face the difficult task of tightening to counter inflationary pressure.
Distributional effects of unconventional monetary policy are not costless to monetary authorities, for central bank monetary policy independence would be at risk if elected officials turn to counter the distributional effects with further economic distortion
Chief Executive Chan of the Hong Kong Monetary Authority (HKMA) made the following concluding remarks at the Jackson Hole Economic Symposium, marking this one of the few occasions when central bank officials highlighted distributional effects of unconventional monetary policy:
- There needs to be more research and study by economists, central bankers and policymakers on the distributional effects of unconventional policy
- Policymakers need to understand more on the trend of rising income and wealth inequality and its economic, social and political impact
- Policymakers also need to study more on the labor displacing impact of technological innovations
- Governments are generally more equipped to tax income but less so in wealth. Policymakers must consider what can and should be done to deal with the rising concentration in the distribution of income and more so wealth. It is also not too early for policymakers to consider what should be done to pre-distribute income by helping those displaced workforce to re-train or adapt to the new environment
HMKA’s focus on QE’s distributional effects should be perceived as an early indicator on growing awareness by prudent policymakers. As financial instability risks morph into political risks to elected officials, unconventional monetary policies and their distributional effects would likely be treated as a political liability rather than economic asset.
Victor Xing is the Principal at Kekselias.
