Ben Bernanke has a new post discussing the relationship between monetary policy and inequality. It is characteristically thoughtful and there is much to recommend it. Unlike some monetary policy cheerleaders, Bernanke is candid that “[m]onetary policy is a blunt tool which certainly affects the distribution of income and wealth”. And he correctly points out that monetary policy operations provoke complex and countervailing distributional effects, rendering simplistic stories hard to judge. Yes, Bernanke acknowledges, monetary easing raises the value of financial assets held almost entirely by upper quintiles and disproportionately by the very wealthy. But “easier monetary policies promote job creation as well as increases in asset prices. A stronger labor market—more jobs at better wages—obviously benefits the middle class, and it is the best weapon we have against poverty.” Bernanke reminds us that, “[a]ll else equal, debtors tend to benefit (and creditors lose) from higher inflation, which reduces the real value of debts. Debtors are generally poorer than creditors, so on this count easier monetary policy again reduces inequality.” To which I can only say, hear, hear!
Some of Bernanke’s protestations are less persuasive. Yes, easy money supports housing prices and “more than sixty percent of families own their home”. But asset price gains are proportionate to value, and the distribution of real-estate value is highly skewed. Plus, the divergence of homeowners and nonhomeowners marks one of the main socioeconomic cleavages in America today, and the whole constellation of housing-price-supportive policies (of which easy money is just one part) have made the chasm ever more risky and difficult to traverse. Because of the wide dispersion of real-estate value, the small, highly leveraged equity positions that are counted as “homeownership”, and the diffuse claims of individual members of households against that equity, citing the gross homeownership rate as a measure of diffusion of housing price gains is misleading.
But the big lacuna in Bernanke’s defense of post-crisis monetary ease (such as it was, pace Scott Sumner) is the unstated counterfactual. Was monetary ease worse along dimensions of distribution than a counterfactual in which tight money, no fiscal support, and a collapse of financial intermediation created a prolonged collapse of output and employment? Surely not, we can agree. But the actual post-crisis policy apparatus was not the only possible configuration of support. Bernanke correctly notes that “if fiscal policymakers took more of the responsibility for promoting economic recovery and job creation, monetary policy could be less aggressive.” Although Bernanke doesn’t state it explicitly, it follows from his discussion that a more fiscal, less monetary, approach to macro stabilization could have retained inequality-reducing employment gains with less inequality-expanding asset price inflation. Bernanke and me and just about everyone else on the planet can join in a big round of Kumbaya tsk-tsk-ing the dysfuction of the United States’ legislative branch.
Less comfortable for Bernanke are counterfactuals of financial intermediation, which touch aspects of crisis policy directly prosecuted or strongly influenced by the former Fed chair. The Bernanke Fed was extraordinarily creative in absorbing private sector risk onto its own balance sheet in order to support and stabilize financial sector incumbents whose prior activity was the proximate cause of the crisis. That was and remains disagreeable on moral hazard grounds. It was also disagreeable on distributional grounds. As recent research reminds us (see Matt O’Brien’s summary), inequality of labor income is largely driven by inequalities of pay between firms and sectors, and compensation in the financial sector is extreme. [See update] Of course, others would have been harmed along with highly compensated finance employees, if we had allowed losses to be realized within financial sector incumbents according to ex ante norms. Stakeholders who would directly have taken losses were disproportionately wealthy creditors and asset holders. The capitalist system itself might have corrected its “long-term trend [towards inequality], one that has been decades in the making”. (Bernanke’s words)
Of course, that italicized directly is quite a caveat. A collapse of financial intermediation would have devastated the entire economy, not just imposed financial losses on disproportionately wealthy creditors. Again, the question is the counterfactual, and the Bernanke Fed itself demonstrated that another counterfactual was on offer. Rajiv Sethi explains:
The main justification for these extraordinary measures in support of the financial sector was that perfectly solvent firms in the non-financial sector would have been crippled by the freezing of the commercial paper market. But as Dean Baker has consistently argued, had the Fed’s intervention in the commercial paper market been more timely and vigorous, it might been unnecessary to provide unconditional transfers to insolvent financial intermediaries. While I do not subscribe to Baker’s view that Ben Bernanke “deliberately misled” Congress in order to gain approval for TARP, his main point still stands: if the Fed can increase credit availability to non-financial businesses and households by direct purchases of commercial paper, than why is any financial institution too big to fail?
It’s a question that the most ardent defenders of the bailouts would do well to address. The impressive numerical estimates of the effects of these policies on output and employment rely on a comparison with a “scenario based on no financial policy responses.” But this is obviously not the proper benchmark. If output and employment could have been stabilized by direct support of the non-financial sector, then we would currently be faced with a different distribution of claims to this output, as well as a different distribution of financial practices.
The case for conventional monetary ease post-crisis, and even for unconventional measures like QE, is easy to make on distributional as well as other grounds, if we presume sensible fiscal policy to be politically unattainable. However, the Fed worked assiduously to prevent a break in the United States’ inequality trend by choices it made with respect to stabilizing the financial sector. There were (and were widely discussed at the time) alternative approaches, some of which the Bernanke Fed itself proved practical with its aggressive and creative support of credit markets via special purpose vehicles in the heat of the crisis. We could relitigate questions of what would have been legal or practical, argue over the costs and benefits and risks of paths taken vs paths not taken. Regardless, it is incontrovertibly the case that policymakers including most emphatically Ben Bernanke chose a path that validated and sustained inequalities that had expanded on the back of very questionable financial activities over alternatives that might have clipped those inequalities dramatically.
This question of counterfactuals is one Bernanke in particular should not be permitted to escape. His widely quoted quip, “If we don’t do this tomorrow, we won’t have an economy on Monday” — where “it” was the extraordinarily finance friendly TARP — deserves a place among the most egregious examples of an expert civil servant wresting control from elected policymakers by presenting a constrained menu of options. TARP, you will recall, was not a spontaneous, last-minute response to the aftershocks of Lehman’s bankruptcy. As Phillip Swagel reported, “The options that later turned into the TARP were first written down at the Treasury in March 2008: buy assets, insure them, inject capital into financial institutions, or massively expand federally guaranteed mortgage refinance programs to improve asset performance from the bottom up.” After months of barely contained crisis between the collapse of Bear Stearns and the bankruptcy of Lehman, the fact that TARP and Meltdown were the only options Bernanke and his colleague at Treasury Henry Paulson had to present policymakers speaks a great deal about their perspectives and priorities.
Finally, all of this talk of the crisis and monetary policy response to the crisis elides the role played by monetary policy in the “very long-term trend…decades in the making”. Prior to the crisis, during the so-called “Great Moderation”, widening inequality was accompanied by an ever diminishing share of output going to labor. That was also the era of “opportunistic disinflation“, under which inflation-obsessed monetary policymakers intentionally clipped employment recoveries to lock-in “disinflationary gains”, um, enjoyed? during recessions. Further, during the Great Moderation, the touchstone of “inflationary threat” in Fed circles, the event most sure to provoke monetary tightening, was an increase in unit labor cost. Unit labor cost is a very dirty measure of inflation. It is, quite precisely, an admixture of the price level and labor’s share of output. Put simply, as a matter of technocratic procedure, the Great Moderation Fed interpreted any increase in labor bargaining power as an event demanding a contractionary response, even if it was not accompanied by an acceleration of the overall price level. Expansions in the cost of capital provoked no similar response. This practice, embedded in an arcane and technical policy regime, helped support the expansion of inequality over the period. (I’ve made this case in more detail here.)
The expansion of inequality since 1980 is a devil with many fathers. But it was not an inexorable fact of nature. It was the product of politics and policy and institutional arrangements that stripped US workers of bargaining power, and stripped US capital of tax obligations and ties to community. The Fed played a role in those arrangements, and not an unimportant role. Yes, post-crisis, post-TARP, in the context of a dysfunctional Congress, easy money has been the best available policy, even on distributional grounds. Yes, the Fed should continue to err on the side of monetary ease, despite the harm done by asset price inflation to social cohesion and to the information content of financial markets. If anything, the Fed’s policy ought to have been even easier, as it would have been under a wiser NGDP level target, for example.
But monetary policy prior to the crisis, and decisions made at the Fed during the event, are not remotely innocent of the catastrophic stratification we face today. Bernanke judges himself and his former institution too narrowly and too generously.
I do wish Ben Bernanke all the best in his new jobs at Citadel and PIMCO and Brookings. I’m sure his new employers have a different perspective on decisions taken during the financial crisis than my own.
Update: The “recent research” arguing that inter- rather than intra- firm changes in pay have driven labor income inequality has sparked a lively debate and some important critiques. See, for example, Matt Bruenig, Nick Bunker, J.W. Mason, and Larry Mishel. Many thanks to Rob Napier for pointing this out. [2015-06-16]: See also Sampling Bias In “Firming Up Inequality” by Marshall Steinbaum.
- 3-Jun-2015, 7:45 a.m. PDT: Added bold update with links to discussion of the Song et al paper cited in the piece.
- 6-Jun-2015, 3:40 a.m. PDT: “
a an expert civil servants servant wresting control”
- 16-Jun-2015, 1:45 a.m. PDT: Added link to Marshall Steinbaum’s critique of the Song et al paper.