Harry Geels: DNB approves its own inequality policy
This column was originally written in Dutch. This is an English translation.
By Harry Geels
It is often claimed that monetary policy exacerbates inequality. According to recent research by DNB, this assertion is incorrect. However, there are some points to be made regarding DNB’s view.
In an analysis, DNB states that monetary policy (such as interest rate cuts and QE) can influence inequality, but that the effects are complex, temporary and limited: lower interest rates initially increase inequality because asset prices (such as house prices and share prices) rise and the wealthy benefit from this, but over time the same policy stimulates the economy and the labour market, leading to increases in employment and wages – which are relatively stronger among lower-income groups – and a subsequent reduction in inequality.
Ultimately, DNB concludes that inequality is primarily determined by structural factors such as technology, demographics and government policy, and that central banks play only an indirect and subordinate role through price stability. Leaving aside for a moment the question of whether endorsing one’s own policy smacks somewhat of ‘self-praise’, we can raise three major substantive objections to the DNB study: 1) the time dimension (direct effects are compared with indirect effects), 2) the effectiveness of those indirect effects, and 3) the assumption of neutrality.
1) Time dimension = rhetorical trick (intertemporal equivalence)
In its study, DNB states that (expansionary) monetary policy initially leads to greater inequality (particularly wealth inequality, via asset inflation), but that inequality subsequently decreases again (for example, because the policy is said to have positive effects on the labour market, amongst other things). This is a normative choice disguised as analysis: current capital gains are equated with future wage increases. DNB is therefore trading direct capital gains for delayed wage increases and describes this, on balance, as a ‘limited effect’. That claim is virtually impossible to substantiate empirically.
2) ‘Trickle-down’ is becoming less and less effective
Quite apart from the difficulty of comparing the direct and indirect effects of policy, it is highly questionable whether ‘trickle-down’ to labour income works at all. The US labour share – that portion of national income going to employees – has been falling for decades due to increasingly powerful companies, globalisation and, more recently, AI. In the third quarter of last year, that ratio even reached its lowest level since the Second World War. Even if monetary policy were to have a positive impact on average, not every worker would benefit from it (self-employed workers, sectoral and generational effects).
Furthermore, monetary policy not only affects wealth and the labour market, but also leads to all manner of ‘wealth transfers’. For example, a policy of (excessively) low interest rates benefits debtors and disadvantages savers. Homeowners benefit twice over: their debt is eroded by inflation whilst the value of their homes rises. Zombie firms may also emerge, which would not survive if interest rates were higher because they could no longer afford the high financing costs. This disrupts all manner of economic and labour market dynamics. Policy neutrality simply does not exist.
3) DNB shifts responsibility for inequality to the political sphere
DNB concludes by arguing that (in)equality is primarily a matter for fiscal policy. This is a classic framing: the central bank is neutral and politicians are responsible. Thus, monetary policy – which therefore has, at the very least, strong distributional effects, if not effects that exacerbate inequality – is presented as technical and neutral, whilst politicians are urged to tackle inequality (implicitly through various taxes). Nor is this neutral advice, as taxes, in turn, have all sorts of (behavioural) effects.
DNB goes directly against the views of well-known economists
What is ultimately missing from DNB’s analysis is any reflection on its own role. Monetary policy is presented as a technical instrument with, at most, temporary distributional effects, but in practice the central bank increasingly determines the price of capital – and thus the distribution of wealth – through interest rate and balance sheet policy (and supervision). Various economists have been warning of this for much longer. Hayek pointed out that manipulating interest rates distorts the price signal for capital and can thus lead to misguided investment decisions.
Ludwig von Mises argued that whilst credit expansion may create temporary growth, it ultimately always leads to structural imbalances that are corrected, for example, by bursting bubbles. Milton Friedman once said: ‘The great danger is that monetary policy will try to do too much.’ He explicitly advocated rule-based policy rather than discretionary (ad hoc, situational) monetary policy.
At the other end of the spectrum of economic schools of thought, Thomas Piketty demonstrates that returns on capital structurally grow faster than incomes, meaning that (initial) capital gains actually accumulate rather than disappear. This means that DNB’s analysis is, at the very least, at odds with Piketty’s central thesis (r>g = growth in capital exceeds growth in income). Incidentally, whilst Piketty does not analyse monetary policy directly, his work does undermine the assumption that capital gains can be offset against wage growth.
In conclusion
Friedrich Hayek once said: ‘The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.’ Central banks and governments ultimately have less knowledge of the effects of their policies than is often assumed, precisely because those effects stem from the behaviour of millions of individual market participants. In that light, DNB’s ‘reassuring conclusion’ is difficult to sustain. The question is not only whether monetary policy increases inequality – whether temporarily or not – but to what extent it has itself become an integral part of that inequality.
Once again, whoever determines the price of money ultimately determines the distribution of wealth as well.
This article contains the personal opinion of Harry Geels