Last Friday, the Kansas City Fed kicked off its annual Jackson Hole Economic Symposium (now held as a virtual event). Fed watchers tuned in to listen to Jerome Powell’s speech, looking for clues about when the central bank will start winding down quantitative easing. But the most consequential discussions at Jackson Hole came after the Fed chairman spoke, because they show the intellectual underpinnings that will guide monetary policy for the next several years. This year’s theme: an “uneven economy,” in which not everyone benefits equally.
It’s certainly important to understand the dynamics of a more polarized economy, but the attention on inequality suggests that monetary policy in America risks taking a wrong turn. The Fed is not the right institution to take on this issue. In trying to do so, it would undermine its own true mission.
For starters, it’s not even clear that the Fed can do much about inequality. Income and wealth inequality in America have grown over the past 40 years, but monetary policy has little control over their causes. Inequality often emerges when an economy undergoes a major transition. More globalization and new technology create new winners but leave others behind; the Fed does not have direct control over either. Monetary policy can at best smooth out the rough edges and reduce the severity of business cycles.
Some economists argue that the Fed can heat up the labor market by keeping interest rates low, resulting in lower unemployment and higher wages for low-income earners. But good evidence is scarce that a hot labor market results in higher wages, at least not after accounting for the inflation that comes with it. The Fed’s primary tools involve lowering interest rates, which increases stock prices, which in turn disproportionately benefits high-income earners, who hold more wealth. And if loose Fed policy results in higher or unpredictable inflation, lower-income Americans will pay a higher cost, since they own fewer assets that rise in value with inflation and spend more of their income on goods more sensitive to inflation.
Before the Fed (or anyone else) tackles inequality, it should assess the potential harms of doing so, which are poorly understood. Traditionally, economists have assumed a trade-off between inequality and growth: a fast-growing economy entails entrepreneurs and innovators receiving big rewards for their risk-taking and vision. Everyone else also eventually winds up better off, but their incomes and wealth don’t grow as fast. Some inequality is thus the built-in cost of having a creative, growing economy.
Some economists worry that inequality is inherently bad for growth. According to one argument, economies with high inequality don’t consume enough, because rich people save more of their income. But it seems a stretch to argue that Americans have been spending too little over the past 40 years. This argument also presumes that growth comes from consumption rather than from the investment (funded by saving) that has fueled such growth in the past.
Others argue that greater concentrations of wealth translate into outsize political power for the wealthy, who then use that power to further their interests. If this is bad for the economy, though, evidence again is scant. The wealthy advocate for many political causes, depending on their political views, and they tend to give generously to various charitable causes. Even if this theory were true, using monetary policy to undermine the political clout of billionaires would be a clear overstepping of the Fed’s mandate, obliterating any semblance of independence from politics.
While the economic case for reducing inequality isn’t clear, a moral case can be made. One could argue that it’s wrong for the few to have so much while the many have so little. But it’s not the Fed’s job to make moral decisions about the ideal distributions of wealth. This is an inherently political calculation—one that should be addressed through institutions directly accountable to voters. Moreover, the tools at Congress’s disposal—tax rates and control over benefits, for example—are better suited for taking on inequality. And these policies involve costs, too, in terms of growth. Voters should be the ones to decide whether they want to pay them.
The Fed’s role is to balance short- and long-term interests, making the hard choices that may harm the economy now in exchange for long-term stability and expansion. Once politics are involved, however, it becomes difficult if not impossible to make this trade-off. The Fed can do what it does because it has a narrow mandate: reasonable inflation and maximum employment. It needs to stay in its lane.