Opinion
Think Loose Monetary Policy Helps Reduce Racial Inequities? Think Again.
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By Paul Wachtel
The Biden administration may propose an expansion of the Federal Reserve’s traditional mandate to maintain stable prices and promote full employment to include reducing racial disparities. Legislation to this effect was introduced in the last Congress and is advocated by Jared Bernstein, a Biden advisor who will be serving on the Council of Economic Advisors. Some Fed officials are sympathetic. Raphael Bostic, President of the Atlanta Fed said in June that the Federal Reserve “can play an important role in helping to reduce racial inequities and bring about a more inclusive economy.” However, these policy makers are mistaken to think that loose monetary policies can be instrumental in improving the lot of Black families.
Their concerns are not surprising given the stark reality of economic disparities. Despite declines in overt labor market discrimination and gains in educational opportunities since the onset of the Civil Rights movement, the gaps between Black and white household income and wealth are as large today as they were in 1950. In 2019, the typical household with a white head has more than six times greater wealth and twice the income than its Black counterpart.
A prominent line of thinking regarding the role of monetary policy in addressing racial disparities is that an easier monetary policy with sustained low interest rates will lower unemployment and increase labor income. Importantly, it does so more for Blacks than for whites. The gap between the unemployment rate of Black and white households, which was over 8 percentage points at the end of the financial crisis, was about 2 percentage points when the pandemic began.
Indeed, the monetary policies that fought the financial crisis had the beneficial effect of reducing the unemployment rate gap between Blacks and whites. However, a loose monetary policy shock that reduces the unemployment gap has a very small effect on earnings. Our research finds that a surprise one percentage point reduction in the Federal Funds rate reduces the gap between average Black and white household incomes by only $300 or 0.6% of the average Black income. Therefore, an expansionary monetary policy has only a very small impact on the Black-white income gap.
Moreover, a closer look at the effects of loose monetary policy on Black and white households suggest that the small effect on the income gap is only part of the story. A loose monetary policy also increases asset prices, particularly for equities and homes. These capital gains disproportionately benefit white households. A one percentage point reduction in the Funds leads to increases in stock prices of almost 5% and house prices by a bit less. The wealth of the typical white household increases by about $30,000, about six times more than the gains to the typical Black household. White households gain more from asset price increases because they are wealthier to begin with and are much more likely to own equities. The run up of the stock market in the last decade – to a large extent driven by monetary policy – hardly benefited Black households because only 35% of Black households own equities.
The monetary policies of the last decade had different effects on Black and white households. White households gained more because they have more financial wealth and hold portfolios that are more concentrated in assets that rise in value when policy loosens. At the same time, monetary policy reduced the gap between Black and white unemployment rates and brought relatively larger earnings gains for Black households. Bringing the two together, however, leads to one stark finding: the reduction in the earnings gap pales in comparison to the effects on the wealth gap.
Our analysis does not bode well for the suggestion that reducing racial inequalities should be added to the mandate of the Federal Reserve. Such a mandate might make it impossible for the central bank to tighten monetary policy when macroeconomic conditions call for it. With the instruments available – all of which work through effects on asset prices and interest rates – a central bank is not able to design policies to reduce the racial income gap without increasing wealth inequality. Clearly, this does not mean that achieving racial equality should not be a prime objective for policymakers. But the tools available to central banks might not be the right ones, and might possibly be counter-productive.
Based on "Monetary Policy and Racial Inequality" by Alina Bartscher, Moritz Kuhn, Moritz Schularick and Paul Wachtel
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Paul Wachtel is a Professor of Economics.
Their concerns are not surprising given the stark reality of economic disparities. Despite declines in overt labor market discrimination and gains in educational opportunities since the onset of the Civil Rights movement, the gaps between Black and white household income and wealth are as large today as they were in 1950. In 2019, the typical household with a white head has more than six times greater wealth and twice the income than its Black counterpart.
A prominent line of thinking regarding the role of monetary policy in addressing racial disparities is that an easier monetary policy with sustained low interest rates will lower unemployment and increase labor income. Importantly, it does so more for Blacks than for whites. The gap between the unemployment rate of Black and white households, which was over 8 percentage points at the end of the financial crisis, was about 2 percentage points when the pandemic began.
Indeed, the monetary policies that fought the financial crisis had the beneficial effect of reducing the unemployment rate gap between Blacks and whites. However, a loose monetary policy shock that reduces the unemployment gap has a very small effect on earnings. Our research finds that a surprise one percentage point reduction in the Federal Funds rate reduces the gap between average Black and white household incomes by only $300 or 0.6% of the average Black income. Therefore, an expansionary monetary policy has only a very small impact on the Black-white income gap.
Moreover, a closer look at the effects of loose monetary policy on Black and white households suggest that the small effect on the income gap is only part of the story. A loose monetary policy also increases asset prices, particularly for equities and homes. These capital gains disproportionately benefit white households. A one percentage point reduction in the Funds leads to increases in stock prices of almost 5% and house prices by a bit less. The wealth of the typical white household increases by about $30,000, about six times more than the gains to the typical Black household. White households gain more from asset price increases because they are wealthier to begin with and are much more likely to own equities. The run up of the stock market in the last decade – to a large extent driven by monetary policy – hardly benefited Black households because only 35% of Black households own equities.
The monetary policies of the last decade had different effects on Black and white households. White households gained more because they have more financial wealth and hold portfolios that are more concentrated in assets that rise in value when policy loosens. At the same time, monetary policy reduced the gap between Black and white unemployment rates and brought relatively larger earnings gains for Black households. Bringing the two together, however, leads to one stark finding: the reduction in the earnings gap pales in comparison to the effects on the wealth gap.
Our analysis does not bode well for the suggestion that reducing racial inequalities should be added to the mandate of the Federal Reserve. Such a mandate might make it impossible for the central bank to tighten monetary policy when macroeconomic conditions call for it. With the instruments available – all of which work through effects on asset prices and interest rates – a central bank is not able to design policies to reduce the racial income gap without increasing wealth inequality. Clearly, this does not mean that achieving racial equality should not be a prime objective for policymakers. But the tools available to central banks might not be the right ones, and might possibly be counter-productive.
Based on "Monetary Policy and Racial Inequality" by Alina Bartscher, Moritz Kuhn, Moritz Schularick and Paul Wachtel
___
Paul Wachtel is a Professor of Economics.