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Author: Don Obrien

The left’s low-rate fantasy makes inequality worse


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Unlike many on America’s left, I’ve always been sceptical that ultra-low interest rates make things easier for the poor. Keeping rates too low for too long encourages speculation and debt bubbles. When they burst, they always hurt those on low incomes the most, as we witnessed during the 2008 financial crisis.

And yet for years, progressives have argued that loose monetary policy and low interest rates are necessary to promote employment, particularly at the lower end of the socio-economic ladder.

This is not the case. While easy money may have helped create a bit of wage pressure in low-end service jobs, unemployment kept falling in recent years even as the Federal Reserve began to raise rates from ultra-low to still-low levels.

Meanwhile, academic research has shown that the tendency of low rates to fuel market bubbles is a key reason behind inequality, since they make the asset-rich richer, while not actually fuelling consumption and demand. In the US, the top 10 per cent of the population owns 84 per cent of equities. There are only so many homes, cars and pairs of jeans that these people can buy.

Chart showing Unemployment vs Fed funds rate, U3 Unemployment versus Effective Federal funds rate. Percent, 2010-20

Most people live on their paycheques. And despite a bit of wage growth over the past six months, incomes on an inflation-adjusted basis are still below where they were in 2019, says Karen Petrou, managing partner of Federal Financial Analytics.

“This is the Kool-Aid: that ultra-low rates promote employment,” she says. “But they don’t.” Most people work to make money, and while central bankers can brew up asset inflation, they can’t create good middle-class jobs. Only business, helped along by the right policy incentives, can do that. Wall Street isn’t Main Street.

Still, the fantasy of low rates somehow creating real growth dies hard. Witness the new progressive push to get rid of the Fed chair, Jay Powell, who last week voiced concerns about inflation being more persistent than previously thought. That could, of course, indicate the need for a quicker tapering of central bank bond buying and/or faster interest rate hikes.

Financial markets never want to hear that, of course. But neither does the political left. Elizabeth Warren, the senator from Massachusetts, called Powell a “dangerous man” for his efforts to roll back some financial regulation following the 2008 crisis. Another Democrat, the head of the Senate banking committee Sherrod Brown, rightly pointed out the very unequal nature of the recovery, but also criticised Powell for saying the test for full employment had been “all but met”, and said that the “Fed cannot pull back every time workers gain a tiny bit of power to demand higher wages”.

Chart showing the Real rate of return. Effective Fed funds rate – Inflation, percent 2010-20

On the one hand, I’m sympathetic to this sentiment. I remember once interviewing a labour activist and Fed adviser who complained that central bankers always pull the punchbowl away just when average people have arrived at the party. Fair enough. With stock prices still near record highs, and US home prices up nearly 20 per cent annually, it’s no wonder that small-time investors are desperate for their slice of the pie. Income growth won’t buy you a house.

And yet, risk is greatest just when the punchbowl is about to be pulled. I worry about the rise of retail speculation on apps such as Robinhood. I also worry that investors with fewer liquid assets are those taking on some of the biggest risks. Consider a recent Harris poll showing that 15 per cent of Latino Americans and 25 per cent of African Americans say they’ve purchased non-fungible tokens, compared with just 8 per cent of white Americans.

This feels way too much like the phenomenon of low-income homeowners being sold dicey mortgages in the run-up to 2008. Yet who can blame people for wanting a sip of the punch when savings rates are zero and inflation is 5 per cent?

The real problem here is that we have left it too late to normalise monetary policy and create a more balanced economy that isn’t just about riding asset bubbles. The perversions in our system were underscored last week by the trading scandals that forced two Fed governors to step down.

But merely cleaning up ethics policy at the Fed or making sure that we don’t loosen banking regulation (both laudable goals) isn’t going to get the US economy where it needs to be. We must all give up on the notion that low rates alone are going to create good jobs and income growth. We should taper faster, and move forward slowly but surely with normalising monetary policy.

Many will argue against doing this, particularly as we move into what may be a long cold winter in which rising fuel prices will hit low-income individuals hard. Yet, as Petrou points out, many of them are already paying double-digit credit card rates. A small tick-up in the Fed funds rate will not be a critical factor, she says, especially given that in the US, those rates mainly trickle through to consumers via home refinancing, which is done mostly by those with high credit scores.

Meanwhile, a small but positive real interest rate would allow small-time savers to starting building a nest egg. That’s a worthy goal no matter what your politics.

rana.foroohar@ft.com



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