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The Fed and Inequality

Zero interest rates have side effects.

Feb 17, 2014, Vol. 19, No. 22 • By CHARLES WOLF
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Increased inequality is not simply an unintended consequence of eased monetary policy; it is also quite remote from the prescribed mandates of the Federal Reserve: principally, market stability and, as a secondary goal policy, full employment. Those who advocate both monetary easing and reduced income inequality should be aware of the tension between them. The more one is concerned with slowing, let alone reversing, the rising pace of inequality, the sooner one should favor “tapering” quantitative easing. Conversely, the more one is concerned with stimulating growth, the more one should favor continued easing. The Fed’s recent announcement of two successive monthly reductions in the quantity of easing is an evident move favoring reduced inequality.

Accurate measurement of inequality is itself problematic. Probably the most-widely used indicator is the Gini coefficient, which measures the gap between each percentage of the population and the corresponding percentage of income (or wealth) received by that percentage. If 5 percent of the population receives 5 percent of income, and all other population percentages receive the corresponding income percentages, then the Gini coefficient is 0, indicating maximum equality of income distribution and no gap between population percentages and income percentages. At the other extreme, if a single recipient were to receive all income, the Gini coefficient would register a peak of 1, representing maximum inequality.

Whether any particular level or specific change in the coefficient—either closer to or farther from equality—is “good” or “bad” cannot be inferred from the Gini number alone. This crucial inference depends on what accounts for the underlying change in the inequality number. Is the change due to positive effects of greater work effort, higher labor productivity, innovation, entrepreneurship, improved technology, more efficient management; or instead, is it due to the negative effects of favoritism, nepotism, collusion, bribery, fraud, insider trading, special privilege, or other forms of maleficent behavior?

For example, is increased income inequality attributable more to such positive effects as those resulting from Steve Jobs and Apple, Bill Gates and Microsoft, and Larry Page, Sergey Brin, and Google; or instead to negative effects such as those emanating from the likes of Ken Lay, Jeff Skilling and Enron, Dennis Kozlowski and Tyco, and Bernie Madoff’s Ponzi schemes? Quite different policy implications follow from the answer. And if the answer is neither all one, nor all the other, how can the positive elements be sustained and the negative behaviors reversed? The answer to this question lies more in the realm of improving corporate governance than in changing public policy.

According to recent U.S. census data, the Gini coefficient for the United States lies midway between .45 and .49, having risen from a low of .39 in 1968 to a high of .48 in 2011. European countries show less inequality than the United States, as do Japan, South Korea, and Israel. The Gini coefficient estimate for China is higher than that of the United States, as is the estimate for Brazil.

These estimates are, of course, based on income before taxes. As noted earlier, after-tax income inequality is substantially less: The Gini coefficient for after-tax income in the United States is perhaps as much as 10 percentage points lower than the before-tax estimate.

It is doubtful that this large a change in the Gini indicator would be found in the after-tax estimates for most other countries. It is also doubtful that quantitative easing has had as large an effect on income inequality in other countries as it has in the United States.

Charles Wolf holds the distinguished chair in international economics at the RAND Corporation and is a senior research fellow at the Hoover Institution.

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