Monetary policy and inequality: Financial channels

Abstract

This paper analyses the effects of monetary policy on inequality over the business cycle via its impacts on returns on assets, the cost of debt servicing, and asset prices in selected advanced economies. Monetary policy easing has a priori ambiguous effects on income and net wealth inequality via financial channels. Effects depend in a complex way on the relative size and distributions of assets, liabilities, and income. In practice, these effects are estimated to be small. A house price increase generally reduces net wealth inequality, while the opposite is true for increases in stock and bond prices. As monetary policy has the potential to affect inequality, monetary authorities face communication challenges. The available research on interactions between monetary policy and inequality does not justify targeting inequality by central banks.

Central Bank Policies and Income and Wealth Inequality: A Survey

“…One limitation of several studies is the absence of a counterfactual analysis – that is, what would have happened to income and wealth distribution if the monetary policy stance had remained unchanged (O'Farrell et al ., ). A counterfactual can be evaluated through scenarios, in combination with other methods.…”

“…Several other studies use microsimulations to analyze the impact of a sudden drop in interest rates, unexpected deflation, or an increase in asset prices on changes of wealth and income inequality (Doepke and Schneider, ; Adam and Tzamourani, ; Adam and Zhu, ; Domanski et al ., ; O'Farrell et al ., ). Simulations accurately replicate the actual wealth and income distribution when time‐series data on the composition of households’ balance sheets are not available.…”

“…Finally, they make simplifying assumptions about the portfolio composition of households, its stability over time, access to asset markets, and the monetary policy impact on interest rates and asset prices. As a result, simulated effects might be smaller than the actual ones (O'Farrell et al ., ).…”

“…In contrast, O'Farrell et al . () report that the distributional effects of expansionary monetary policy on average are negligible, but differ considerably across OECD countries, that is, income inequality increases in some countries and decreases in others in response to a monetary policy shock.…”

“…Similarly, O'Farrell et al . () argue that monetary policy might be less effective in reducing income inequality in downturns than increasing it in upturns.…”