Scratching Fed’s equity itch may yield unexpected result
“The very first requirement in a hospital [is] that it should do the sick no harm.” — Florence Nightingale
When the Federal Reserve was created in 1913, long before it aspired to be a fourth branch of government, its sufficient mission was to preserve the currency as a store of value. In 1978, Congress encouraged institutional imperialism by mandating Fed policies promote “maximum employment.”
Ben Bernanke, the Fed chair from 2006 to 2014, construed this as a single capacious mandate for “promoting a healthy economy.” If so, the mandate excludes nothing.
Now, it seems, the Fed feels an irresistible itch to participate in every important government policy endeavor.
In 2020, Joe Biden said the Fed should “aggressively target persistent racial gaps in jobs, wages and wealth.” If so, the Fed’s newest mandate is
Washington’s word du jour, “equity.” This word implies, without defining, a social outcome different than — and superior to — the Constitution’s guarantee of equal protection of the laws.
The Fed’s economists, who had better be polymaths, must now plunge monetary policy and financial regulation into the political and philosophical challenges of pursuing social justice. First, however, they should read the Federal Reserve Bank of New York’s report “Monetary Policy and Racial Inequality.” If racial equity means less racial inequality in incomes and wealth, the Fed faces a conundrum: The monetary policy it thinks the nation needs now and for the foreseeable future (the Fed did not foresee 2008 in 2007, or the economy’s current strength four months ago) is harmful.
The Fed indicates that, until at least 2023, interest rates will remain near zero. (In Fed-speak, “accommodative monetary policy.”) The New York Fed’s report says: Very low interest rates increase employment of Black households more than of white households, although “the overall effects are small.” Low interest rates, however, exacerbate Black-white wealth differences.
Low rates stimulate the economy, drawing marginal workers into the labor market, and a tight labor market pushes up wages. But low rates also cause money to flow into assets such as stocks and houses in search of higher yields. But “the median black household has no stock holdings, nor owns a house,” so “accommodative” policy “bypasses the majority of black households.”
Over a five-year period, this policy causes the Black unemployment rate to fall by about 0.2 percentage points more than the white unemployment rate, but the policy increases stock prices by as much as 5% and house prices by 2%. And if it increases inflation, this disproportionately burdens low-income groups that devote larger portions of their incomes to consumption.
White households, with high wealth-to-income ratios, benefit from the asset price increases resulting from accommodative Fed policies. This is the distribution of the gains from accommodative monetary policy: “About 80 percent of all gains accrue to households in the top 5 percent of the wealth distribution and about 50 percent go to the top 1 percent. Notably, this distribution is substantially more unequal than the distribution of wealth itself.”
The New York Fed’s report says that although “the distributional effects of monetary policy” are “outside central banks’ formal mandates, central bankers are increasingly discussing distributional issues.” When they are not discussing, one hopes, what Nightingale knew.