Rising Inequality: The Side Effect of Monetary Policy

The wealth effect theory – where rising asset prices makes consumers feel wealthier, causing them to spend more – has been the prime driver behind the expansionary monetary policy pursued by the world’s major central banks in their efforts to stimulate an economic recovery. The flaw in this theory is that real wealth is held by the wealthy, thereby intensifying an already dangerous side effect of capitalism, where the earth’s wealth becomes concentrated among the few.

In January, OXFAM released a report on global wealth that highlighted the growing inequality in the world. “In 2014, the richest 1% owned 48% of global wealth”. As shown in Figure 1, it is projected that by 2016, the top 1% will have more wealth than the bottom 99%, a staggering statistic. However, more thought provoking is the fact that the wealth of the 80 people who top the Forbes rich list, an estimated net wealth of $1.7 trillion in 2014, exceeds that of the bottom 50% in the world, which has been decreasing over the last five years

Figure 1: Share of global wealth of the top 1% and bottom 99% respectively

Source: OXFAM “Wealth: Having it All and Wanting More”

The reality is that while rising inequality may not be desired by the world’s major central banks it is an accepted side effect of their monetary policy action, in their efforts to promote economic growth and employment. In February, Vítor Constâncio, Vice-President of the European Central Bank, gave a presentation at the 2015 US Monetary Policy Forum. Among the risks and potential costs of more expansive monetary policy, including Large Scale Asset Purchases, he listed “Wealth effects and increased inequality”, noting that “a stronger economy and lower unemployment can mitigate but not eliminate this possible side effect.”

I am not trying to bring your attention to the obvious, that the world is an unequal place. Rather it is to question whether the policies that are being pursued by the world’s central banks are actually working against their objective of promoting a sustainable economic recovery. After all, six years on, interest rates remain at emergency levels because the global economic recovery is still not on a sustainable footing.