Some say low interest rates cause inequality. What if it was the other way around?
It’s just one article of faith among many in the financial world: The Federal Reserve’s low interest rate policies and other measures designed to stimulate the economy are pushing up the value of stocks and others. active on the moon, and therefore are a major cause of high wealth inequality. .
This idea can be heard in documentaries, newspaper opinion pieces, and many segments on cable financial news. He can also be back.
New evidence suggests that high inequality is the cause, not the result, of the low interest rates and high asset prices seen in recent years. That’s a provocative implication of new research presented at the Federal Reserve Bank of Kansas City’s annual Jackson Hole Economic Symposium on Friday (which was conducted virtually because of the pandemic).
Seeing how this new notion relates to booming markets – and the risks to financial stability each time it ends – means asking why interest rates are so low, prices of financial assets so high. and what the Fed has to do with it.
Advanced economies have experienced low interest rates for over a decade. These can be seen less as the result of central bankers’ decisions and more as the consequence of powerful global forces pushing them down, creating a corresponding surge in asset prices.
Indeed, a global savings glut has caused a fall in the “natural rate” of interest, also called r * (and pronounced r-star): the rate that neither stimulates nor slows the economy.
Central bankers, in this story, are the equivalent of highway drivers who have to adapt their speed to road conditions. The Fed has kept rates low for the past decade because it is these rates that keep the economy stable. If he had tried to push them higher, the result would have been a recession.
“Central banks are now enjoying the fall of r-star, which means they will have limited ability to tighten monetary policy in the future,” MIT economist Kristin Forbes said in a presentation at the symposium .
But it begs the question of why this glut of savings exists.
The article, written by Atif Mian of Princeton, Ludwig Straub of Harvard and Amir Sufi of the University of Chicago, examines two main explanations: the demographic effects of the accumulation of retirement savings by the baby boom generation, and the effects of greater inequality, given that the rich save more of their income than the middle class and the poor.
They found that the role of higher inequality was much larger than that of demographics.
It is not that high incomes have increased their savings rate. On the contrary, they were winning a bigger share of the economic pie; According to the researchers’ calculations, the share of income going to the richest 10 percent of wage earners has risen to over 45 percent in recent years, from around 30 percent in the early 1970s.
The result of top earners earning more, and therefore saving more, represents trillions of dollars in additional savings over the years, accounting for 30-40% of private savings from 1995 to 2019.
Thus, whatever the causes of the increase in income inequality, most likely a combination of technological changes; decline of union power; globalization; changes in tax policy; and the win-win market dynamic – it sparked a surge in asset values for these wealthy people.
“As the rich get richer in terms of income, it creates a glut of savings,” Professor Mian said. “The savings glut is forcing interest rates down, making the rich even richer. Inequality breeds inequality. It’s a vicious cycle, and we’re stuck in it.
Their paper is hardly definitive, and other economists at the symposium noted a few problems – for example, that the fall in the natural interest rate has been a global phenomenon, occurring even in countries with trends of inequality. incomes different from those of the United States. States. And Jason Furman, the Harvard economist, noted that the widening inequality was most intense in the years before 2000, when the fall in the natural interest rate has mostly occurred since then.
But no matter how strong income inequality is in driving low rates, high asset prices, and higher wealth inequalities, the situation puts the Fed and other global central banks in a tough spot.
“These forces that are pushing r-star down are probably so powerful that the Fed could never fight them,” Professor Sufi said in an email.
And whatever the cause, the result has been a situation where even a modest rate reversal could weigh down debt obligations, causing unpredictable spillover effects.
“The transition to a higher rate environment could be quite bumpy, given that a lot of asset values and debt sustainability assessments are based on very low interest rates” over a very long period of time, Donald Kohn, former Fed vice chairman who is now at the Brookings Institution, said in a speech at the symposium calling for more aggressive action to contain risks in the financial system.
At the very least, the new document is further proof of how some of the world’s most entrenched economic problems overlap in complex ways. And that implies that what happens next, about interest rates, inflation, growth and everything else about the economic future, is more closely related than it first appears.