Global Finance

Monetary Policy and Income Inequality

 The Challenge

Traditionally the distribution of income and monetary policy have been considered separate issues. This view has recently been challenged for two reasons: i) the potential drag of inequality on the economic recovery after a recession and ii) the impact that monetary policy might have on inequality.

The rising income inequality observed in the US over the last few decades has been accompanied by recoveries that have been branded ‘job-less’. After the last three recessions in the US, the recovery of employment was much slower than in previous recessions. The most recent ‘Great Recession’, in particular, was followed by the slowest recovery since the Second World War. Policy makers and researchers have started to consider these two phenomena interrelated. A more uneven distribution of income means that the income of rich households is growing faster than the income of poorer households. Since rich households typically have a lower consumption propensity than poor households, this might dampen aggregate demand and thus slow down the recovery after recessions, especially when the economy is stuck in a liquidity trap.

This poses a challenge for monetary policy for two reasons. First, growing inequality might affect the transmission mechanism of conventional monetary policy because a higher (aggregate) propensity to save makes interest rates less reactive to changes in the money supply, i.e., monetary policy might be less effective in a more unequal society. Second, monetary policy could exacerbate inequality, particularly unconventional monetary policy. Since the ‘Great Recession’ monetary policy of many developed countries has been constrained by the zero-lower-bound on interest rates. This means that the central banks could not lower interest rates by as much as they wanted because they could not charge negative interest rates. Therefore, the central banks resorted to unconventional measures such as Quantitative Easing (QE). This stabilized the economy but also fired up asset prices. Since wealthier households hold more assets, both in relative and absolute terms, economists and policy makers are concerned that QE would overly benefit rich households, and thus worsen income inequality.

The question is how central banks should respond, or whether they should respond at all, to the challenge of growing inequality and its relationship to monetary policy. The redistributive effects of monetary policy are not well understood and the traditional view is that monetary policy should not be used for redistribution. However, the potential link between rising inequality and slow recovery suggests a different solution where central banks actually care about income inequality and its relationship to both traditional and unconventional monetary policy measures. If these exacerbate inequality, and if this actually hinders the recovery, alternative approaches might have to be considered. Are, e.g., forwardguidance and nominal GDP targeting the more effective instruments in the presence of high inequality. Do they have more beneficial effects on inequality? Or should fiscal stabilization policy gain more importance in the light of higher inequality?

What Banking for Economic Dynamism?

The Challenge

The role of banks for economic dynamism is paramount. Diverse people such as Edmund Phelps, Muhammad Yunus, and David Cameron have discussed how banks may foster an economy’s ability and preference to innovate. In the past, banks actively lent to households and small businesses, which they carefully monitored. In recent times, banks have shifted their focus toward lending and borrowing in financial markets, particularly channeling lending toward standardized securities, which have promised higher yields at lower risk. These transactions involve lower monitoring costs than lending to small businesses, and they have relied upon financial innovations such as securitization. The result of these developments has been a decrease in economic dynamism against a backdrop of an increase in financial dynamism.

One apparently simple policy solution is to issue governmental guarantees that incentivize banks to lend to small businesses and innovative firms once again. But this policy sounds too familiar from recent US experience. There, governmentsponsored enterprises increasingly guaranteed mortgage lending and loans to small and medium enterprises. That experiment did not end well. Some argue that the incentives induced by the government led to poor monitoring and the indiscriminate issuance of credit. The rapid expansion of the quantity of mortgage credit and a rapid deterioration in its quality were major factors accompanying the housing boom and the financial crisis.

This episode shows how well-intentioned government guarantees may easily lead to massive and indiscriminate lending and adverse selection, and eventually unsustainable distortions. It also shows how poorly-designed policies jeopardize macroeconomic stability and have adverse consequences for economic welfare. It is therefore important to understand how to derive sustainable policies that encourage banking for economic dynamism. What incentives could encourage banks to refocus on relationship-building and the careful monitoring of small businesses and innovative enterprises? Is it desirable to discourage banks from engaging into securitization on both the lending and borrowing side of their balance sheets? And can we learn from the experiences of micro finance or venture capital in creating new forms of banking which safely expand credit to small and innovative businesses rather than to well-established incumbents?

The Future of Central Banking and Financial Market Reform

The Challenge

The global financial crisis has revealed regulatory failure in financial markets and demonstrated the urgent need for reform. In particular, it is now widely accepted that in addition to established microprudential policies, macroprudential policies aimed at increasing the stability of the financial sector as a whole are imperative. But an active debate has emerged over what role the central bank should play with this augmented set of policies.

What is the role of unconventional monetary policy in overcoming financial crises and economic slumps. Under what circumstances can it led to a revival of sustainable long-term growth? How can the associated threat of asset price inflation be avoided?

The traditional pre-crisis view was that monetary policy and financial regulation were separate tasks and should be conducted by separate institutions.

In the post-crisis period, there is disagreement over whether central banks should be actively involved in monitoring and regulating the banking system. What is the scope of monetary policy?

What are the desirable short- and long-term objectives of central banks? Should financial market supervision be located at central banks? How should the central bank deal with potential conflicts of interest if trade-offs between different policy goals arise? Does the additional mandate make central banks more prone to political influence? How can the independence of central banks be effectively protected? Will the additional mandates enhance or endanger the credibility of central banks in maintaining price stability? What extra instruments could central banks use to regulate the financial sector?

Economics, Intersubjectivity and the Crisis of the Future

The Challenge

Sacrificing Younger Generations to Economic Growth

The current crisis is a crisis of “confidence in the future” – in short, crisis of the future. Literally speaking, that phrase is meaningless although often used. Confidence or trust is a matter of intersubjectivity, and the future is neither a subject nor even an actuality. However, our economic societies have developed a specific relationship to the future that makes the latter “present”, as it were: they organize themselves around a common image of the future which they take as fixed benchmark or lodestar although they know quite well that they cause in part the future to be what it will be. They are “future-takers” in the same way as agents in the market are supposed to be “pricetakers”. This form of “bootstrap” or “self-transcendence” of the future is what gives our societies the impetus to always move forward.

Under the label “crisis of expectations” many economists have acknowledged that this mechanism is broken. Testimony of it is the erosion of faith in economic growth. From the above it is possible to derive the following statement: the condition of possibility of capitalism is that its agents believe that it is unbounded in time. The sacralization of growth derives from this. Growth is the promise that the future will always remain open. For many converging and systemic reasons that need to be analyzed doubts as to whether this can or will be the case undermine the belief that the promise will be held. This will have, and already has dire consequences. The most serious one is the sacrifice of the current generation of young people to what is perhaps already a fallen goddess: Growth.

Historical analysis as well as philosophical considerations teach us that the economy has taken over the role that religion performed in holding society together. Does the current crisis foreshadow a time in which the economy itself will become unable to fulfill this mission?