Contributing Writer: Zachary Heintz | May, 2022
In 1896, William Jennings Bryan, a former Nebraska congressman, gave a speech at the Democratic National Convention that would win him the Democratic presidential nominations in both 1896 and 1900. His historic “Cross of Gold” speech made monetary policy the front and center issue of left-leaning populists who based their presidential campaign off the argument that expansionary monetary policy was a form of revolutionary wealth redistribution from the wealthy eastern financiers to poor indebted farmers. Today the tables appear to have turned. During the Covid-19 Pandemic it has been common to hear an argument like the one expressed in this May 2021 Vox piece:
“The issue is, the Fed is a much more powerful force on Wall Street than it is Main Street. Its programs to help small and midsize businesses and states and cities have been far less effective than those set up to help corporations and asset prices.”
There is a popular view that in this K shaped recovery, the Federal Reserve’s quantitative easing programs are protecting the powerful and leaving the rest of us high and dry. The reality is a little more complicated. The Federal Reserve’s asset purchasing program provides stimulus to the economy by pulling a few key levers. The first is the one that everyone can visually see, asset prices. By buying up large quantities of government and mortgage-backed securities, the Fed feeds demand for financial assets, pushing up their price and making rich people who disproportionately own stocks a whole lot richer. The second channel is through bank lending. When the Fed buys securities from financial institutions it pushes a lot of money into the hands of banks who then lend that money back out to Main Street. Because these banks are flush with cash, theoretically they will lend the money at lower interest rates. Most of the wealth and debt held by middle class families is held in the value of their home and the size of their mortgage. When real interest rates go down, the real cost of a mortgage goes down and demand for housing goes up. In practice, banks may hold onto much of that cash as excess reserves because the Fed has been paying them interest on those reserves since 2008. Regardless, by lowering interest rates the Fed can decrease the debts and increase the wealth of middle-class households. The third big lever of monetary policy is employment. When interest rates go down and the price of securities goes up, it becomes more expensive to save your money rather than spend it. That drives an increase in consumption which creates jobs and increases wages, boosting the finances of poorer and middle-class households who rely primarily on labor income to support themselves.
Research by Epstein and Montecino published in 2015 looked at the relative importance of these levers during the 2008 financial crisis. They found that constricted lending standards made it hard for low-income and middle-class households to take advantage of lower interest rates by refinancing their mortgage. As a result, when comparing boosted securities prices and increased employment they found that it was likely that the securities prices had the more significant effect, resulting in a mild increase in inequality. Taken alone, this paper would support the conclusion that quantitative easing really is propping up the rich, even if not as disproportionately as we originally thought. However, another paper by Doepke, Schneider, and Selezneva published in March 2019 arrived at the opposite conclusion by focusing on the wealth effects of rising home prices on middle-class households. They found that expansionary monetary policy helped the middle of the distribution more than it did, rich households.
For this pandemic, there are additional facts in favor of team Fed. Compared to the financial crisis, the pandemic recovery has seen less harsh lending tightening and a quicker lending recovery. Easier lending means access to mortgage refinancing and home price increases, which means more wealth and lower debt payments for middle-class homeowners.
Another key concern is inflation. The papers by Epstein and Montecino and Doepke, Schneider, and Selezneva assume that inflation is low in their estimates. While that may have been a fair assumption in 2009, the current post-pandemic recovery has seen the creeping monster of inflation rear its head once more. If monetary policy has caused higher inflation, this could also play a role in wealth redistribution. Another paper by Doepke and Schneider, this one written in 2006, suggests that inflation could be a good thing for poorer households with more debts. They suggest that households that are younger and middle-class tend to have more debts than assets that are nominal, or in other words that do not rise as quickly as inflation. Older and richer households, by contrast, have more nominal assets than debts. This means that when inflation occurs, money is redistributed to younger middle-class households as their debts fall and along with richer households’ wealth. For some in the middle of the distribution with fixed-rate mortgages, the creeping monster of inflation might be more like Sesame Street than Godzilla. Critically, this analysis assumes that your wages rise with inflation. If wages fall once you adjust for inflation, poorer households that use labor income as their primary source of income could have to take on more debt to pay rising prices. The Bureau of Labor Statistics reported in January 2022 that real average hourly wages had fallen by 1.7% since January 2021. This estimate is, of course, variable depending on what inflation metrics you use, but there is a real possibility that the inflation is outpacing wages. This effect may not outweigh the other wealth effects, but even if in the aggregate rich households end up losing more wealth than middle-income households to inflation, that may be little solace for a family with a higher grocery bill.
Given the recency of the pandemic, there is no way to know for certain who got the most cash from the Fed’s money printers. The research is far from settled and there are a lot of competing effects going on at once. However, the evidence seems to imply that similar to free silver in the 1890s, the Fed’s expansionary monetary policy benefits middle-income households disproportionately by raising their wages and shrinking their mortgage. Considering these findings, it seems little premature to accuse the Fed of crucifying mankind on a cross of QE.
REFERENCE
Juan A. Montecino & Gerald Epstein, 2015. “Did Quantitative Easing Increase Income Inequality?,” Working Papers Series 28, Institute for New Economic Thinking
Matthias Doepke & Martin Schneider, 2006. “Inflation as a Redistribution Shock: Effects on Aggregates and Welfare,” NBER Working Papers 12319, National Bureau of Economic Research, Inc.
Pandit, Meera. “How Will the Covid Recovery Compare to the Financial Crisis Recovery.” J.P. Morgan Asset Management, February 24, 2021. https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/market-updates/on-the-minds-of-investors/how-will-the-covid-recovery-compare-to-the-financial-crisis-recovery/.
Rep. The Lost Decade of the Middle Class. Pew Research Center, Washington DC, August 22, 2012. https://www.pewresearch.org/social-trends/2012/08/22/chapter-7-income-and-wealth-by-income-tier/.
Stewart, Emily. “Why Stocks Soared While America Struggled.” Vox. Vox, May 7, 2021. https://www.vox.com/business-and-finance/22421417/stock-market-pandemic-economy.
Veronika Selezneva & Martin Schneider & Matthias Doepke, 2015. “Distributional Effects of Monetary Policy,” 2015 Meeting Papers 1099, Society for Economic Dynamics.
Read the full article at: https://issuu.com/uwequilibrium.com/docs/eq_final_2022/26