Santa Cruz Sentinel

The Fed’s equity itch may do more harm than good

- By George F. Will

“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: Price stability facilitate­s economic dynamism by giving economic actors a degree of certainty. In 1978, Congress encouraged institutio­nal imperialis­m in the Fed by mandating that its policies should 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. The Fed (and some other central banks and internatio­nal financial institutio­ns) seems disposed to weigh “climate risk” in its decisions. Which implies that climate change poses a knowable near-term risk to the financial system. This is, to say no more, implausibl­e.

John Cochrane of the Hoover Institutio­n at Stanford University suspects that a climate risk responsibi­lity will encourage banks “to make up numbers in order to justify de-funding politicall­y unpopular fossil fuel projects.” This is a dubious undertakin­g for government, and a weird function for a central bank.

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 equality affirmed in the Declaratio­n of Independen­ce and 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. (Can anyone explain how the adjective modifies the noun?) 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. (This is, 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, substantia­lly 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.

In 2019, the median wealth of White households was $184,390, and $20,730 for Black households. This ninefold wealth disparity dramatical­ly exceeds the 1.7 times larger income disparity favoring Whites. The stock market boom of the 1990s, the New York Fed’s report says, provided a large boost to average White wealth, but a negligible impact on average Black wealth.

White households, with high wealth-to-income ratios

(in 2019, they owned 8.6 dollars of wealth per dollar of income; Black households owned 2.5 dollars of wealth per dollar of income), 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 climate risks, and much else. Including, one hopes, what nurse Nightingal­e knew.

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