A Chicago Booth school research review note (or article or brief) published in May talks of the research by Sufi, Mian and Straub on how the top 1% investment in Treasury bills, notes and bonds and deposits in financial institutions end up as household debt for the bottom 99% which is relatively and mostly unproductive. The paper is problematic because it is looking at at the wrong place for the causes. Both the phenomenon they describe – the wealthy ending up with too much wealth and hence cash to invest and the lower-income households taking on more debt – are traceable to a common factor. That is monetary policy of the Federal Reserve.
By training their guns on the top 1% – not that I have a particular problem with it – they are not holding the Federal Reserve accountable for perpetrating huge wealth and income inequality.
Ultra-loose monetary policy through a combination of low interest rates and liquidity provision fuel asset markets. Rich hold assets and they are able to enhance the return on such asset holdings through leverage as well that low interest rates amply facilitate and amplify as well.
To the extent that extraordinarily loose monetary policies fuel a much greater rise in equity prices than in real estate prices, then monetary policy can boost the wealth of the top 1% or 10% compared to the rest of the 99% or 90% and that is what has been happening.
In fact, this was pointed out in a brief but useful essay in the BIS Quarterly Review of March 2016. The essay is titled, ‘Wealth inequality and monetary policy’. Some extracts:
While low interest rates and rising bond prices have had a negligible impact on wealth inequality, rising equity prices have been a key driver of inequality. A recovery in house prices has only partly offset this effect. Abstracting from general equilibrium effects on savings, borrowing and human wealth, this suggests that monetary policy may have added to inequality to the extent that it has boosted equity prices.
Considering the tails of the wealth distribution – not shown here – generally reinforces this picture. The share of securities holdings, equity in particular, tends to be even higher at the top 5% or 1% of the distribution. Conversely, housing accounts for a higher share in the lowest net wealth quintile, for which low net wealth is in many cases a reflection of high levels of mortgage debt. In a number of cases, net wealth is negative, suggesting that liabilities, in the form of mortgage, consumer and other debt, exceed assets.
Since 2010, high equity returns have been the main driver of faster growth of net wealth at the top of the distribution.
What is interesting is that this essay points out that even in Japan, which is one of the least unequal among advanced nations, ultra-loose monetary policy has played a part in fomenting a rise in equity prices and hence a rise in inequality. This is what footnote no. 16 of the essay says:
Frost and Saiki (2014) study the impact of unconventional monetary policy on income inequality in Japan in a vector autoregression (VAR) framework. Using household survey data, they find that quantitative easing widened income inequality, especially after 2008 when policy became more aggressive. They identify capital gains resulting from higher asset prices as the main driver.
Corporate businesses do not invest in productive assets in America. They used to do that a lot in other countries to save on costs. They engaged in share buyback and the managers paid themselves very well. Workers were laid off as production went offshore. Worker insecurity restrained wage growth. Workers made up for it through borrowings and mortgage debt thinking that the rising value of their homes would keep them safe and offset weak income growth.
Loans are fixed and legal obligations. Real estate prices can go up and down and hence low income households bore the brunt of the real estate crash of 2008. The cycle repeats.
To say that banks recycle the excess savings of the top 1% into unproductive debt for low-income households is to misunderstand how banks create assets. The authors have not taken into consideration BoE research published in 2014 and which is borne out by empirical research (Richard Werner) as well that banks do not wait for deposits to create assets. They create money and THEN create deposits, in its wake.
Banks engaging in real estate lending (what the authors call unproductive debt) is partly lazy banking. Real estate loans carry lower risk weight because they are collateralised (Alan Taylor, et al) and mortgage loans are easier to securitise and get off the books as well. Third and a weaker consideration is that real estate loans to lower income households also gets a relatively freer pass on politically correct considerations.
So, the paper rests on flimsy foundations or is empirically unfounded. The common problem is the excessive and prolonged reliance on monetary policy to drive long-run economic performance as opposed to using them as short-run business-cycle management (or, aggregate demand management) tools.
Second, the review states:
Mian, Straub, and Sufi lean toward the global savings glut theory. Mian and Sufi argue in 2018 research that a rapid flow of foreign funds into the US triggered a credit-supply expansion that boosted household debt, which they say was a major factor in igniting the financial crisis.
This too is problematic and faulty. There are proximate and seemingly logical causes and there are longer-term considerations. Foreign funds flowed to America because extremely low US interest rates caused a surge in the value of other currencies against the US dollar. The ‘too-much-too-quick’ appreciation met with natural and unsurprising resistance from other countries. They accumulated foreign exchange reserves and those reserves were deployed in US Treasury and agency debt, etc. Even in stocks. Again, the underlying cause and the proximate cause are different.
Third, the authors appear to have recycled stale and impractical solutions to the problems that they had identified. Given that the problem identification was wrong, naturally the solutions were superficial too:
Their proposed solutions involve taxation—either a more progressive tax system or a wealth tax—through which the government can finance spending and investment, or redistribution programs that benefit lower-income households.
The review does well to point out, citing other researchers, the practical difficulties of implementing a wealth tax:
As of 1990, there were 12 countries in Europe taxing net wealth, but now that is down to Norway, Spain, and Switzerland. When France did away with its version in 2018, the prime minister said it had caused many millionaires to flee.
That is why any proposal to tax the wealth of the rich has to come from the rich themselves as part of a broader social compact. But, that is the stuff of fantasy and dreams these days, for the most part.
The practical suggestion:
Research by Booth’s Eric Zwick and Princeton’s Owen Zidar suggests that reforms such as rolling back special deductions for pass-through businesses, which they say collectively generate more taxable income for the top 1 percent than do big C corporations, could be a key part of a tax plan that raises up to $5 trillion over the first decade of implementation. Pass-through businesses typically include medical and law practices and other types of consultancies.
This makes sense. I do remember reading about the magnitudes of these pass-through in ‘The Captured Economy’ by Brink Lindsey and Steven M. Teles. Perhaps, it is a relatively unheralded book. It offers specific solutions and backs up its assertions with data and evidence. In a way, it provides the all-important evidential backing for the assertion that capitalism needs to be saved from capitalists.
In conclusion, one can speculate on why academics, in general and for the most part, tend to give a free-pass to central bankers. But, it is, well, speculative. Further, to be fair, it is not just academics who give a freer pass to fellow academics. This piece by Daniel Moss in Bloomberg on the (subtle or not) policy shift by the European Central Bank is proof that the cosy network is bigger and wider.