Hammers and Nails: Central Banks and Inequality

There’s an old saying that “if your only tool is a hammer, then every problem looks like a nail.” It’s about the temptation to use the tool you have on every problem that comes up–whether the tool you have is actually appropriate for the problem. Hammers work well with nails: they aren’t so helpful with screws, or when trying to water the flowers.

The situation with central banks and economic inequality is a little different. In this case, some of those who are focused on inequality have wondered whether the central bank might offer an appropriate hammer for this particular nail. But in then just-published Winter 2023 issue of the Journal of Economic Perspectives, Alisdair McKay and Christian K. Wolf explain why this is a case of the tool not fitting the problem in  “Monetary Policy and Inequality.” 

Economic inequality exists for many reasons, of course. The question is whether or how actions by central banks–say, decisions to raise or lower interest rates–might change the level of economic inequality. Perhaps the main complication in the analysis here is that monetary policy will affect different groups in different ways. For example, if you have borrowed money with an adjustable-rate mortgage, you might benefit from lower interest rates. If you haven’t borrowed money, but instead were hoping to receive interest payments on past savings, then lower interest rates will hurt you. If you are unemployed or low-paid, then to the extent that lower interest rates can stimulate the economy and lead to more jobs and higher wages, you are better off. Lower interest rates also tend to encourage investors to scale back on investments that are linked to interest rates (like corporate bonds) and instead to shift over to stock markets. If you own stocks, you benefit from this effect; otherwise, not so much.

Thus, the challenge is to look at how different groups, defined by age and income, are likely to be affected by monetary policy–and in turn how that affects the extent of inequality. After working their way through the evidence, they argue:

On the one hand, the incidence of the individual channels of monetary policy transmission to households is quite
uneven. For example, mortgage payments and stocks have much stronger effects at the top of the wealth distribution, while other debt services and labor income have stronger effects at the lower end. On the other hand, once aggregated across all channels, the overall consumption changes are much more evenly distributed. …
While there are some differences across groups, we view them overall as relatively modest. … The key takeaway is that … expansionary monetary policy roughly scales up everyone’s consumption by the same amount as the aggregate, leaving each household’s share of total consumption approximately unchanged.

The “dual mandate” of the Federal Reserve’s monetary policy is to worry about output and jobs when those seem at risk, and to worry about inflation when it seems to be rising. If the Fed was to add inequality as another objective, then the central bank would have to address the question of whether it should, in some situations, allow either more inflation or higher unemployment in pursuit of fighting inequality. But the McKay and Wolf essay suggests that monetary policy does not lead to substantial shifts in inequality in the first place. Thus, when it comes to the nail of economic inequality, monetary policy is not the hammer you are looking for.