COLUMN-Fed trapped in Catch-22 situation on inequality, rates: Jamie McGeever

(The opinions expressed here are those of the author, a columnist for Reuters.)

ORLANDO, Fla, Sept 1 (Reuters) – The Fed can’t win. Its only real route to fighting rising U.S. income inequality – blamed last week for trapping interest rates at ever lower levels – will only exacerbate more egregious wealth gaps.

A paper published at Jackson Hole by the Kansas City Federal Reserve last week claimed rising income inequality over many decades was largely responsible for structurally lower interest rates because it channeled more money to richer households who typically save more.

But if income disparities are indeed the main reason for the falling equilibrium interest rate – the rate that neither stimulates nor cools the economy at large – the Fed has an invidious choice.

Its only way of narrowing income gaps is to ensure the economy runs hot enough for long enough to generate wage growth at the bottom half of the income spectrum, and its only real way of doing that is leaving monetary policy looser for longer.

But as is obvious once again over the past year, ever looser policy only helps widen already gigantic wealth gaps by forcing up the price of stocks and bonds held mostly by the rich.

The paper piqued interest because it claimed that four decades of incomes at the top rising much faster than for the rest of society has been the main cause of increased savings and subsequent decline in structural interest rates.

Not the other way around, as many Fed critics argue, and a much more powerful force than the simple demographic shift toward an ageing population, as has widely been assumed.

“Income inequality today remains extremely high relative to its pre-1980 level, and there does not appear to be any reversion in inequality in the near future,” the paper’s here three economists wrote.

“If the inequality view is correct, then it suggests that macroeconomic forecasters should closely track the evolution of inequality when forecasting movements in (equilibrium interest rates) going forward.”

RECORD WEALTH INEQUALITY

The broad consensus among economists is that the Fed will lay out a timeline for tapering its $120 billion-a-month bond purchases later this year, end the program by the end of next year, but not start raising interest rates until 2023.

These blunt instruments may be able to effect change in growth, employment and inflation on the aggregate level over the medium term, but their capacity to reduce income inequality is less obvious.

“The Fed has a limited set of tools. There needs to be a recognition of the Fed’s limitations,” said Jeanette Garretty, managing director and chief economist at Robertson Stephens Wealth Management.

“If income inequality exists because the top end of the spectrum has taken something from the lower end of the spectrum … I have yet to see the conclusive argument for what the Fed should do.”

The paper, authored by three non-Fed economists, ties in with research by the Bank for International Settlements in June that found that inequality is largely due to structural factors “well outside the reach of monetary policy, and is best addressed by fiscal and structural policies.”

While the BIS found that large-scale Fed asset purchases since 2008 have not coincided with a “noticeable” rise in net wealth held by the top 10% or top 1%, the concentration of wealth at the very top over recent decades is indisputable.

Federal Reserve data show that the richest 1% of Americans held 29% of the nation’s assets in the first quarter this year. That’s a record high since the data series began in 1989, when they held 20.8% of national wealth, and marks a steady increase from the post-2008 crisis low of 22.8% in early 2009.

By contrast, the bottom 50% of the population held 5.3% of U.S. assets in March, a record low and substantially down from the series high of 8.7% in late 1995.

Similarly, the top 1% of income earners held a record 26.7% of the nation’s wealth in March, substantially up from around 17% three decades earlier, while all the cohorts in the bottom 80% have seen their share decline over the same period.

Tightening policy and raising rates would probably hit asset prices, denting incomes and wealth at the very top. But it would also risk slowing the economy and raising unemployment, hitting middle- and low-earners the hardest.

As Garretty at Robertson Stephens Wealth Management notes: “The Fed is stuck between a rock and a hard place.”

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