Is the Federal Reserve Contributing to Economic Inequality?

SF Fed

  • […] a few recent facts suggest the Federal Reserve might play a role in generating economic inequality.   As the economy has slowly reopened, employment growth has rebounded, exceeding most expectations. But this growth has erased only about half of the original losses. In September, employment was still down by almost 11 million people from its recent peak. Those are bigger losses than we saw during the Great Recession. In contrast, financial markets have recovered completely. After dropping nearly one-third in February and March, all major U.S. stock indexes have recovered their declines.
  • Looking at the two recoveries I have just described—the economic one and the financial one—it seems unfair. Another example of Wall Street winning and Main Street losing. Of a few advancing while so many others fall behind (Kuhn, Shularick, and Steins 2020).
  • The Federal Reserve has a dual mandate—full employment and price stability. We achieve these goals primarily by adjusting the short-term interest rate. Our interest rate decisions make it more or less expensive for consumers and businesses to borrow money. This guides spending decisions, which impacts hiring, wages, and ultimately inflation.
  • When it’s working well, our policies provide the foundation for a positive feedback loop—consumers spend, firms invest and hire more workers, and a wide range of households build income and wealth. This is the virtuous cycle of growth that ultimately delivers a strong, sustainable, and inclusive economy.
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  • But how do our policies work in practice? To get a sense of this, let’s consider the last expansion—the longest in recorded U.S. history. After taking significant measures to stabilize the economy in the wake of the 2008 financial crisis, the Fed committed to a period of sustained low interest rates to support the labor market and return inflation to 2%.
  • The benefits were material. The length and strength of the expansion pushed the unemployment rate to near-historic lows. This created real opportunities for a large number of sidelined Americans, many of whom were thought to be permanently out of the labor force. By early 2019, employers were hiring African American and Hispanic workers at rates equal to or higher than those of white workers (Petrosky-Nadeau and Valletta 2019). This reduced long-standing unemployment gaps, narrowing them to historic lows. The same thing happened for those with a high school diploma: hiring rates rose, unemployment fell, and gaps narrowed relative to college-educated workers
  • By the end of the expansion, these improved employment outcomes were leading to faster growth in wages and income for less-advantaged groups. Between 2016 and 2019, median wage growth for low-wage workers was more rapid than for high-wage workers, reversing a pattern that had dominated in previous years. This narrowed the relative gaps in wages between those in the lowest earnings quartile and all other groups (Robertson 2019).
  • The better-than-average wage growth translated into better-than-average growth in household incomes. In 2019, median household income for Black and Hispanic households rose by more than 7%, compared to less than 6% for white households (Semega et al. 2020).
  • Finally, these improvements also showed through to wealth. As the economy continued to expand, so did the value of assets, including housing, businesses, and stock market holdings. Gains on assets were especially rapid for those at the bottom of the wealth distribution (Bhutta et al. 2020).  Between 2016 and 2019, families with the lowest net worth saw the largest growth in their holdings. This late-cycle pattern gave less-wealthy households a chance to reap some of the benefits that had been captured disproportionately by higher net-worth individuals earlier in the cycle.
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