Traditional monetary theory holds that central banks are guided by a mandate of protecting price and financial stability. In the case of the US Federal Reserve, the dual mandate holds that it must maintain equilibrium inflation and unemployment, adjusting interest rates to maintain that equilibrium. Yet an emerging chorus of economists and policy-makers are making the case that an equality objective should be a component of central banks’ monetary policy responsibilities.
Such a concept would have been almost inconceivable only a decade ago. In 2021, however, Senator Elizabeth Warren, Representative Maxine Waters and Senator Kirsten Gillibrand proposed the Federal Reserve Racial and Economic Equity Act. As Warren put it, ‘The Fed can use its existing authorities to help reverse the serious racial gaps in our economy, including in our current recovery from the Covid-19 crisis – and our bill will require the Fed to do so.’
The bill was passed by the House of Representatives but died in the Senate. Yet it remains a notable moment in growing attempts to explore US inequality and the possibility of monetary policy as a part of the solution. Figure 1 shows that central bankers are discussing inequality with greater frequency. In 2004, inequality was mentioned in less than 1% of speeches by central bankers in both emerging and advanced economies. In 2021, that figure was over 9%.
Figure 1. Central banks increasingly focused on inequality
Share of central bank speeches that mention inequality, %
Source: OMFIF analysis, Bank for International Settlements
Why is there such newfound interest in discussing economic inequality? Part of it may have to do with the considerable growth of inequality in many advanced economies since the 1970s (Figure 2). From 2009-12, the top 1% of US earners captured 91% of total growth, according to data collected by Emmanuel Saez, professor of economics at the University of California, Berkeley. The aftermath of the 2008 financial crash coincided – to no one’s surprise – with a souring of the public’s attitude to the failed trickle-down economic dictums that characterised the politics of the previous 20 years in both the US and the UK.
Figure 2. Inequality has grown considerably in advanced economies
Gini coefficient 1970-2015, 0-100 (highest inequality)
Source: OMFIF analysis, Bank for International Settlements
Many economists (including those at the European Central Bank, Fed and Bank of England) believe that central banks’ use of near-zero interest rates and quantitative easing in the aftermath of the 2008 crash worsened wealth inequality. Lower- and middle-income households have limited access to financial markets and equity investment opportunities, in large part because their marginal propensity to consume each dollar of income is greater than high-wage individuals. And so, a loose monetary policy that spurs asset equity market growth tends to kindle wealth inequality since it chiefly benefits wealthier asset owners.
Central banks argue that the benefits of such policies outweigh these costs, but the recognition of the disequalising impacts of post-2008 policy helps explain why central banks are being asked to address inequality in their monetary policy. Moreover, any relationship between interest rates and inequality may be self-reinforcing. In 2021, Atif Mian, Ludwig Straub and Amir Sufi showed that rising income inequality played a principal role in explaining the decline in real interest rates in the US. In 2022, BoE Governor Andrew Bailey echoed this conclusion at an OMFIF event.
What would it look like for central banks to include inequality as a component of their mandate, alongside price stability and employment? Given the already complex demands of balancing inflation and unemployment, answers to this are nebulous at best and there are competing theories for how it could be done.
Research by Tobias Broer et al and Carl Walsh offers an interpretation of a two-agent new Keynesian model, whereby the economic universe is delineated by capital owners, who hold claims on profits but do not supply labour, and workers, who do not have a claim on profit but do supply labour. Such a model has implications for economists’ calculations of consumption elasticity and individuals’ forward-looking orientation towards their income. And such a delineation could, in theory, allow central banks to integrate inequality targets within their mandates.
Niels-Jakob Hansen, Alessandro Lin and Rui Mano build upon this by showing, in a Taylor model of central bank decision-making, that monetary policy could maximise welfare if it targets inflation, unemployment and output gaps while also placing a small negative weight on consumption inequality. This model can also offer an explanation for why real interest rates have been in decline, since disequalising shocks (such as skill-biased change and outsourcing) have induced inequality, which under this Taylor model would implore central banks to keep real interest rates lower than otherwise.
These results are endogenous to the model and there are inherent complexities of developing a central bank equality objective. The underlying assumptions of these theories are debatable, and the risk of miscalculation grows with the difficulty of accurately charting a countries’ time-varying wealth and income distribution. Moreover, the kind of ‘holistic’ approach such an objective might call for would make it more difficult for central banks to maintain consistency between leadership regimes and to set forward guidance. An equality objective may be beyond the scope of central banks’ core responsibilities.
This does not mean that central banks should ignore economic inequality when implementing their monetary framework, however. Although equality objectives may be difficult to implement, increasing awareness of inequality is not.
Central banks should take this further, using banking sector statistics to report on how inequality impacts the efficacy of their policies, and how their policies will impact inequality. Central banks should then take any disequalising effect into account when crafting their monetary responses, and they should articulate these impacts to the public and to legislators. Such an approach is similar to how central banks monitor international developments in assessing the outlook for the US economy.
Beyond this, however, central banks’ job should remain the imposing task of maintaining price stability and financial stability in the interest of maximising public welfare. The fair and efficient distribution of economic resources is a public good and central banks’ growing interest in discussing and reporting on inequality is a positive development that should be encouraged. But central bank policy is no substitute for effective social security, shock adjustment assistance and financial market regulation.
Moreover, a central bank’s political independence is particularly important to its functioning, especially in a moment of heightened polarisation and partisanship. A more holistic model that identifies inequality as a specific mandate could threaten to erode that independence and encourage more partisan behaviour. Such an outcome would be both economically hazardous and politically toxic – central bankers are unelected officials with no mandate to weigh into partisan policy debates beyond their monetary responsibilities.
Issues of economic inequality are thus principally issues of legislation, best left to elected officials that represent the will and interests of the public. Yet, given the clear relationship between monetary determinations and distributional outcomes, the emphasis by central banks on inequality as a consideration – but not a mandate – is an auspicious and badly needed development.
Julian Jacobs is Economist at OMFIF.