Monetary Policy and Income Equality

by Alex Merced

In a previous article I discussed that redistribution of income isn’t necessary to create equality, instead you should unleash market forces by reducing barriers into wealth markets. In this article I’d like to make the argument that another culprit in creating growing inequality is not only market controls but monetary policy, especially expansionary policy.

What is Monetary Policy?

Monetary policy is a policy tool, often controlled by central banks, that revolves around the control of a country’s money supply and credit. Monetary policy mechanisms usually consist of interactions with the banking system that make it easier or harder for banks to extend more credit. A couple of major mechanisms include:

Discount Lending: When banks have liquidity or solvency issues they may borrow from other banks to keep things going, but when there isn’t a bank to borrow from they can go to the central bank and borrow against typically high quality assets(“safe” stable liquid assets like government debt). These loans are usually in the form of deposits on the banks balance sheet (record of asset and liabilities).

Open Market Operations: Another way of getting money in and out of financial institutions is to enter short term contracts called Repurchase Agreements (repos for short) where the Central Bank lends money by purchasing an asset today with a contractual promise the bank will repurchase it from the central bank in coming days (the reverse of this is called a reverse repo when central banks need to take money from the banks).

Quantitative Easing: Similar to open market operations without the agreement to repurchase, basically the central bank outright sells or buys assets depending on their goals which can have the largest impact of three mechanisms discussed in this article.

What are contractionary and expansionary policy?

The central bank usually conducts either contractionary policy or expansionary policy:

Expansionary Policy: By increasing the amount of money in the economy (usually in the form of lending to banks) the amount of credit available increases. This is usually done when  central banks are worried about unemployment (due to what I believe is a misguided belief in a trade-off between unemployment & inflation). So by inflating the money supply several things happen such as…

– The lowering of real interest rates (rates after inflation) makes it unwise to hold money, or even relatively safe investments (since the return will still be negative after inflation), encouraging investment in riskier higher return investments

– Lower interest rates will encourage more borrowing (although the lower rates would discourage lending, the low real rates make it even worse not to).

Contractionary Policy: By decreasing the amount of money in the economy you end up with the opposite result.

How does this affect inequality?

While inflating the money supply may not immediately in the short run inflate the price level, it can have several pernicious effects on the distribution of wealth.

1. Drives up the prices of capital goods: the low nominal and real rates will make longer term, capital intensive investments more attractive resulting in driving up the prices of capital (natural resources, property, etc.). The result is that this increase in capital asset values increases return to the owners of capital (often the wealthier portion of the population) and squeezes out the resources available to firms to pay labor even if the purchasing power hasn’t depreciated yet (the low income population depends on wages a bit more).

2. Financial assets will also be driven up in value: Since financial institutions are the mechanism for increasing the money supply, money that isn’t lent will often go into buying financial assets like stocks. One signal that prices of stocks may be drifting away from the real value of the company is rising Price/Earning Ratios (often referred to as expanding multiples on financial television). This means the owners of financial assets (often the wealthy) get a pseudo-free gain on their assets increasing disparities in wealth. This is often justified under the idea of the “Wealth Effect” that people seeing their assets increase in value will spend and invest more.

While there is nothing inherently wrong with consumer prices and asset values rising, the intervention of the central banks creates a one sided arbitrary and regressive redistribution of wealth in the name of financial stability.

Advertisements

2 comments

  1. The Tax Code, excessive regulations, the national debt and the Federal Reserve are the major causes of the widening inequality gap.

    Solutions:
    Abolish Tax Code and IRS
    Enact Fair Tax (national sales tax)
    Minimize regulations to only what is absolutely necessary.
    Balance the budget.
    Start decreasing the national debt.
    Abolish the Federal Reserve as we know it. Replace with automated system as Milton Friedman suggested until better solution is discovered.
    Allow gold and silver as legal tender.

    National Debt. $17 trillion costs or is financed by each household, who is ultimately responsible for that debt. This comes out to $148,000 per household if paid for in one lump sum. Financed for 15 years at 5% interest it would take a monthly payment of $1170.
    Do not be fooled each household pays this one way or another, not the rich; whether you pay it directly in taxes and fees or by a lower standard of living than you would otherwise have if the government had not spent that money.
    The question is: Is your household getting its money’s worth?

    The inequality problem is counterintuitive. Big government equals more inequality. Smaller government equals less inequality.

    The middle class is the byproduct of a free market economy; it is not manufactured by a politician’s tax gimmicks, minimum wage laws, or government redistribution of wealth.

    There is no such thing as a living wage, there is only a wage that someone can afford to pay.
    You have to tailor your living around your wage, not have government tailor your wage around your living.

    It is about supply and demand. If you have an easy time filling your employee needs, you offer lower wages, if you have a hard time filling your employee needs, you offer higher wages; because if you do not your competition will and you will be out of business.

    It is not about what people deserve or what is fair or what is just, it is about what the market will bear.

    Blame the consumer for shopping for the lowest price and blame the voter for voting for government to fix their problems.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s