Expansionary Monetary Policy: Unequal Distribution and Effects
BY John Koutsonikolis
The Federal Reserve is maintaining negligent monetary policies. Its maintenance of low-interest rates and its expansion of credit–money printing–generates unequal distributions of wealth in which only the tiny minority at the top reap the rewards. In response to the COVID-19 pandemic, the Reserve has been rapidly expanding its balance sheet and setting interest rates at record low levels, resulting in a more substantial divide between wealth and poverty in the U.S. The Reserve used expansive and aggressive monetary policy to expand economic activity and prevent macro-collapse of the economy. During lockdown, many businesses were forced to close, temporarily close, or lay off workers. Some of the main consequences of the Federal Reserve intervention include devaluing the dollar, inflating the prices of financial assets, and producing greater wealth inequality.
A staggering statistic indicates that the median savings account balance for American families is $5,300 (Perez). Families with savings accounts see little growth in their funds as interest rates stay low, which is usually accompanied by inflation to deteriorate the real value of that money further. Families trying to save for their needs such as college, a car, rent, and other essentials or beneficial products and services are left in a struggle to realize their dreams. Families might be pressured into stock market exposure but do so with risks inherent in those types of investments for which they might not want to take on. This dilemma is problematic as families of lower wealth and income desire a safe way to grow their wealth. Saving through a savings or money market account once provided that security, but now it potentially generates more of a risk to one’s future than a certainty. Some families resort to debt in the forms such as credit card debt, student loans, and car financing. Even though interest rates might be low for these debts in a lower interest rate environment, it can still place one into a debt repayment cycle imprisonment that further hurts the economically disadvantaged. Even the most disciplined savers of money will feel the burden of slowly compounded interest and inflation.
Our current monetary structure, along with a financial system that is increasing in size and complexity, unequally distributes wealth into the hands of a few. A potential strategy to combat this problem includes reducing the Federal Reserve’s balance sheet to combat low-interest rates. Increasing the cost of money—decreasing available credit—encourages saving so that families can reach their financial goals.
It is crucial to understand how the Fed’s tools contributed to low-interest rates through expanding the money supply, which resulted in increased wealth inequality. The M2 money supply is a reading of the total amount of dollars in circulation (“The Fed – What is the Money Supply?”). The St. Louis Fed branch reports the M2 supply in a graph as a part of their economic data research. Their graph shows that the money supply has increased from $7.5 trillion in 2008–around the financial crisis–to $19.5 Trillion as of February 2021 (“M2 Money Stock”). That is approximately a 160% increase in the supply of money circulating in the economy. Since March 2020 when M2 was at $15.5 trillion, M2 increased around 26%. Notably, from 2007 to 2016, the median wealth of lower-income and median-income families decreased 42% and 33% respectively, while the median wealth of upper-income families increased 10% (Kochhar). Wealth inequality is intensified by this massive increase in circulating credit, bringing about low nominal interest rates and negative real rates.
An increase in the money supply–circulating dollars–decreases interest rates as the cost of money becomes cheaper and borrowing money becomes more accessible. The Fed targets the Effective Federal Funds Rate when considering an expansionary policy. As of March 2021, the Effective Federal Funds rate stands at 0.07%. The Fed explains the importance of this interest rate by stating, “The federal funds rate is the central interest rate in the U.S. financial market . . . [it] indirectly influences longer-term interest rates such as mortgages, loans, and savings, all of which are very important to consumer wealth and confidence” (“Effective Federal Funds Rate”). From the Fed’s explanation, the interest rates they set have significant consequences on the economy–potentially good or bad. As a result of the low-interest rate environment, the average annual percentage yield (APY) on savings accounts in the United States is 0.07% as of March 2021 (Goldberg). Holders of dollars and people without heavy stock market exposure, primarily middle-class families, earn very little return, which discourages saving.
The reality of savings rates is even harsher than what the low positive nominal interest rates indicate. Real interest rates consider the effects inflation has on devaluing the currency. The real interest rate is equal to the nominal interest rate minus inflation (Brock). Longtermtrends provides a way to compare these three components (nominal rates versus real rates versus inflation). The chart on the website displays the nominal interest rate for a one-year U.S. Treasury Bond and the corresponding inflation level for that month. Take, for example, January 25, 2021, where the nominal interest rate was 0.09%, and inflation was estimated to be at 1.68%. This results in a real interest rate of negative 1.59% (Frank). Therefore, savers are paying to save their dollars as inflation erodes their value. Low rates are further intensified when inflation is factored into the equation, which some might neglect to consider if they only examine the nominal APY rate advertised for their savings account.
It is critical to tie all these numbers and policy actions together to see the unequal distribution of wealth generated by the Fed’s expansionary monetary policy in our economic climate. A theory that summarizes the unequal distribution of new money and resulting inflation is called the Cantillon Effect. In an issue from the Quarterly Review of Austrian Economics, Arkadiusz Sieroń describes the Cantillon effect as an increase in the money supply pushing the new money into wealthier individuals first, which results in an expansion to the wealth gap. The demand for goods will depend on who receives the new money, which leads to the assets held by the wealthy to experience the most price inflation: “Cantillon famously noted that if the new money comes into the hands of savers, that the interest rate would decrease, but if it comes into the hands of consumers, the interest rate would increase, as entrepreneurs would need to borrow more to meet the increased demand for goods.” (Sieroń 504).
This effect can be noted in our current economic environment. The new money put into the economy flows directly into assets such as stocks, bonds, real estate, and even riskier financial derivatives. As mentioned, this new money is flowing into investments–savers–causing interest rates to decrease. Since the new money is not flowing into the hands of consumers, there is little increased demand for goods. Working-class people cannot see the effects of expansionary policy as the money goes into these assets instead of into the real economy, and, therefore, interest rates stay low.
Sieroń expands on this by stating that “the Fed’s monetary expansions tend to help the wealthy, banks, big corporations, and the financial industry more generally. Subsequently, as prices rise, the Fed’s policy hurts retirees, those on fixed incomes and wage earners who receive the new money last, if at all” (Sieroń 505). The money being pumped into the system flows into the financial markets and, thus, inflates the values of those securities. Inflation in securities such as stocks helps those who own them as they appear wealthier. When inflation comes in the form of goods represented by the Consumer Price Index (CPI), it hurts the middle and lower class as they now must pay more for those goods. The combination of increases in CPI and negative real returns on savings accounts means one’s wealth will erode as their purchasing power decreases. The money does not trickle down to middle- and lower-class savers due to the Fed’s use of monetary tools increasing the dollars on balance sheets of financial institutions, which in turn funnels that money into financial assets benefiting the wealthy.
It is possible to see the effects of the Fed’s monetary policy actions through various indicators and observe the inequality between the wealthy, middle-, and lower-class households. A Forbes article states that “the Federal Reserve study found that only about one-third of families in the lower half of the income scale had stock holdings. In the next 40% of the income scale, about 70% of households held stocks, while households in the top 10% of the income scale had stock ownership rates above 90%” (Ghilarducci). The S&P 500 has seen an increase of approximately 80% since the lows of March 2020, when the Coronavirus pandemic hit (“S&P 500 Price”). The higher a family falls in the income and wealth distribution, the more exposure it will have, on average, to the stock market. With most of their assets placed in equity-tied holdings instead of cash and cash equivalents, high-income families realize prodigious gains in their wealth that are incomparable to the average American.
Despite this drastic recovery in the stock market to above pre-pandemic levels, unemployment still sits higher at 6% compared to pre-pandemic levels (“Unemployment Rate”). When wages are examined, it is even more evident that the monetary measures are not being evenly distributed into the economy. A Pew Research Center report found that “today’s average hourly wage has just about the same purchasing power it did in 1978” (DeSilver). Wages have not been able to keep up or outgrow inflation, while assets in the financial markets have seen astronomical increases in price. With very few households in the lower-income scales holding stocks, and with most of them being owned by wealthier individuals, only the rich will continue to realize appreciation in their wealth from Fed stimulation.
A final indicator to examine is the velocity of money, which is the frequency at which one dollar is spent or circulated in the economy over a certain amount of time. According to the chart from the St. Louis Fed, the Velocity of M2 Money Stock is at historical lows, sitting at 1.134 in Q4 of 2020 (“Velocity of M2 Money Stock”). Despite all the mandates set out by the Fed, the new money is not flowing through the economy and creating new transactions as indicated by the money velocity. By this metric, one could infer that money is being held stationary in assets rather than being used for transactions in the economy. All these indicators provide evidence that new money flows into financial assets, benefiting the wealthy, hurting savers of dollars, and contributing to wealth inequality.
Some might argue that the Fed’s manipulation of the money supply is essential to providing stability to the economy and financial markets. The Federal Reserve Bank of San Francisco describes the benefits of central bank interference. They discuss how increasing the money supply can grow the economy’s aggregate demand, leading to increased production and employment while in turn boosting consumption among spenders. The piece also acknowledges that common stock holdings will increase in price, making people more willing to spend with their asset appreciation (“How Does Monetary Policy”). While these tools help the economy in times of distress, one can argue that only the people holding the assets will benefit and boost economic activity. In contrast, people with little or no connection to these avenues will be hurt as their dollars lose value to inflation.
One potential solution to this problem can be to reduce the Federal Reserve’s balance sheet to allow the money supply to decrease, and therefore cause interest rates to increase. Raising interest rates is just a possible way to help the lower and middle class as savings dollars primarily influence them, but any remedy comes with negative consequences. A Harvard Kennedy School report states that “a high-interest rate environment would create sets of winners and losers across the global economy. The U.S. Social Security system trust funds, for example, could avoid projected bankruptcy through higher interest income. . . . In addition, corporate pension plans would benefit from rising interest rates.” (Healey). The benefit of higher interest rates would help middle-income households not connected to new money avenues such as stock investments. This could potentially help decrease the wealth inequality gap as households can use their dollars to save instead of having their dollars lose value through low interest rates.
Central banking’s structure directly benefits a specific group of people while disadvantaging a more significant part of the economy. Having a system that values holding dollars can help narrow the divide between Wall Street and Main Street and give greater power to those not connected to modern wealth creation avenues.
Works Cited
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