Asger Lau Andersen, Niels Johannesen, Mia Jørgensen, José-Luis Peydró April 19, 2021
Who wins – and by how much – when central banks relax their monetary policy regime is a key political question. This column presents new data on the distributive effects of monetary policy based on detailed administrative data at the household level. The authors show that the gains from lower policy rates exhibit a steep income gradient, with increases in income, wealth and consumption being modest at the bottom of the income distribution and greatest at the top.
Monetary policy is an important tool to stabilize the economy. This was particularly evident during and after the global crisis of 2008-2009 (Cui and Sterk 2018), with some market commentators even claiming that monetary policy has become “ the only game in town ” (El-Erian 2016). In the context of the current Covid-19 crisis, central banks have again played an important role (e.g. European Parliament 2021).
While monetary policy is generally designed to affect economic aggregates, the distribution of gains and losses matters for several reasons. First, it shapes the effect on aggregate demand as households systematically differ in marginal propensity to consume (Kaplan et al. 2018). Second, the renewed interest in income inequality (Milanovic 2016) and wealth inequality (Saez and Zucman 2014) has sparked an important debate on how monetary policy affects these phenomena. This issue has also caught the attention of policymakers, with some arguing that a looser monetary policy reduces inequalities because it mainly helps low-skilled workers find jobs (Draghi 2016). But others have pointed out that the better-off also benefit from rising asset prices, which means that the net effect on inequality is ambiguous (Bernanke 2015).
In a recent study, we analyze the distributive effects of monetary policy on income, wealth and consumption (Andersen et al. 2020). Our main source of data is individual tax records for the entire population of Denmark, with detailed information on income and balance sheets for the period 1987-2014. This equates to over 70 million observations per year. In tax records, we look at all the major components of household disposable income (eg wages, dividends and interest) as well as major components of the balance sheet (eg housing, inventories and debt). We combine tax records with other administrative data sources, above all an automatic register with information on car purchases – an important component of sustainable consumption.
The aim of the study is to estimate how a fall in the key rate affects households at each position in the income distribution. A major empirical challenge is that the Danish policy rate can be endogenous to local economic conditions. We meet this challenge by harnessing the Danish monetary authorities’ long-standing commitment to exchange rate stability (implying that Denmark has effectively imported its monetary policy from Frankfurt for 35 years). When the ECB changes its policy interest rate, the Danish central bank usually changes its rate on the same day to restore the interest rate differential consistent with a fixed exchange rate. This introduces an exogenous source of variation in the Danish key rate which we exploit for identification. Concretely, we use changes in the ECB’s key rate as an instrument for modifying the Danish key rate, while comprehensively monitoring the macroeconomic environment, cross-border spillovers and secular trends in inequality.
Our first set of results concerns the effects of monetary policy on disposable income. We show that a looser monetary policy increases disposable income to all income levels, but that earnings are very heterogeneous and increase monotonically in income level. As shown in Figure 1, a decline in the policy rate by one percentage point increases disposable income by less than 0.5% at the bottom of the income distribution, by around 1.5% at the median income level, and more than 5% for the top 1% over a two-year horizon.
We identify the main economic channels underlying this result by considering each component of disposable income separately. In line with theory and the perception of policymakers (e.g. Draghi 2016), looser monetary policy has the greatest effect on wage incomes at relatively low income levels, reflecting a considerable increase in employment for this group. . But most of the other components of disposable income (for example, earnings in the form of higher business income, higher stock market income, and lower interest charges) contribute to a positive income gradient.
Our second set of results concerns the effects of monetary policy on asset values through changes in house prices and stock prices. We document that a looser monetary policy creates capital gains for all income groups, but with a steep positive income gradient. As shown in Figure 2, a drop in the policy rate by one percentage point increases the value of assets by about 20% of disposable income at the bottom of the income distribution and about 75% of disposable income at the top of the income distribution. a two-year horizon. (involving asset returns on housing and stocks of 6-8%). This suggests that the effects of looser monetary policy through asset appreciation are generally much larger than the effects of higher disposable income. The income gradient largely reflects the fact that high-income households hold more assets relative to their disposable income and, to a lesser extent, that returns on assets created by monetary policy are higher.
We also study the distributional effects of monetary policy on consumption and wealth accumulation. Intertemporal budget constraint requires that the gains generated by a looser monetary policy, whether in the form of disposable income or capital gains, be either consumed or added to household wealth. But by modifying market interest rates, monetary policy also modifies the trade-off between consumption and saving more broadly, as captured by the intertemporal elasticity of substitution. The results indicate that the consumption and wealth gains from a looser monetary policy are both very unevenly distributed.
Theoretically, debt has a direct impact on exposure to multiple channels of monetary policy and can further shape consumer responses to the extent that it represents a financial constraint. We empirically show that household debt plays an important role in the transmission of monetary policy. Within income groups, we show that the estimated effects of monetary policy tend to increase monotonically with ex ante leverage. Within groups with similar leverage, the income gradient is generally lower than in the full sample. Nevertheless, a significant heterogeneity remains even after taking into account the leverage effect. Notably, the richest 1% stand out with larger gains from looser monetary policy than any other income group at each level of debt.
Finally, to relate our results to the larger body of existing research on inequalities (e.g. Piketty 2014), we undertake a simulation exercise that summarizes the distributional implications of our estimates. The results suggest that looser monetary policy unambiguously increases income inequality by increasing income shares at the top of the income distribution and lowering them at the bottom. As shown in Figure 3, taking into account the direct and indirect channels, reducing the policy rate by one percentage point increases the share of aggregate disposable income of the richest 1% by around 3.5% over a period of time. two years and reduced it by almost 2% for the lowest income group.
Andersen, AL, N Johannesen, M Jørgensen and JL Peydró (2020), “Monetary Policy and Inequality”, CEPR Working Paper DP15599.
Bernanke, B (2015), “Monetary Policy and Inequality,” Brookings Institution Blog, June 1.
Wei, C and V Sterk (2018), “The Powers and Pitfalls of Quantitative Easing,” VoxEU.org, January 9.
El-Erian, MA (2016), The only game in town: central banks, instability and avoiding the next collapse, New York, NY: Random House.
European Parliament (2021), “The ECB’s monetary policy response to the COVID-19 crisis”, ECON in Focus briefing, February 9.
Draghi, M (2016), “Stability, equity and monetary policy”, 2nd DIW Europe conference, Berlin, 25 October.
Greg K, B Moll and G Violante (2018), “Monetary Policy According to HANK”, American Economic Review 108 (3): 697-743.
Milanovic, B (2016), “Introducing Kuznets Waves: How Income Inequalities Rise and Fall in the Very Long Run”, VoxEU.org, February 24.
Saez, E and G Zucman (2014), “Exploding wealth inequality in the United States”, VoxEU.org, October 28.