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Monetary policies and Inequality

Monetary policies and Inequality

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Summary

Until recently growing inequality in distribution of income across households continues to attract attention across a wide variety of economist and scholars. The focus has increasingly been on the role of monetary policy in effectuating inequality in an economy. On one hand economist argue that an accommodative monetary policy seeks to reinforce inequality in distribution of wealth and income. On the other hand, proponents of expansionary monetary policy argue that the best move to reducing inequality and boosting employment would be in incorporating an expansionary policy. In retrospect, Furceri and colleagues set to analyze The Effects of Monetary Policy Shocks on Inequality in an economy.  Using measures of unanticipated changes in rates of policy over a panel of 32 advanced markets economies, the authors find that the effect of the expansionary policy is largely inconclusive since it may increase or reduce income inequality over time depending on the type of expansionary policy, share of labor income the state of the business cycle and redistribution policies. The effect is in fact much pronounced in countries that have higher share of labor income and a corresponding small redistribution policy. The authors conclude by stating that there is a direct relationship between an increase in monetary policy and inequality, however policy changes that are driven by growth in innovation activities in the economy are associated with lower levels of inequality. For instance the authors noted that “unexpected decrease of 100 basis points in the policy rate reduces inequality by about 1¼ percent in the short term and by about 2¼ percent in the medium term.”

Relationship to the module

In the USA the Federal Reserve (the Fed) are tasked with oversight of issues of monetary policies, stability in prices, maximum employment as well as moderate long term interest rates. As reflected in this module, monetary policy is a subject of macroeconomic policies. It responds to and affects variables such as aggregate employment, inflation, and long term interest rates. Thus, in pursuing macroeconomic objectives the techniques and strategies that Fed deploys  can significantly affect inequality in the country to an extend where household characteristics like income, age and income are related with wealth or income levels and changes in monetary policy. Feds can control monetary policies because it can broadly alter credit conditions and money supply in the economy. Because purchase of capital goods and household consumers exert a major influence on spending, a wider definition of monetary policy would combine statements economic forecasts, policies, directives and actions that are particularly associated with the central bank. Therefore, the monetary policies that the Fed device has a long term influence on other rates in the economy.

Personal Analysis

Inequalities incomes and wealth distribution has been rising in the USA for decades. In this light, Social immobility plus inequality are certainly issues that require first priority in general economic policies. A number of theoretical policies have been proposed to outline the way that monetary policies may affect inequality. However, inequality as we see today is a result of decades of structural changes in the economy including economy, demographic trends, changes in technology, labor markets as well as institutional changes (Bullard, 2014). In effect, the effect of these factors is much more pronounced compared to monetary policies. Most economists nonetheless agree that monetary policies have a perpetual role in the economy. This is because when properly managed monetary policies can promote economic stability and prosperity by mitigating against the effect of inflation and recession in the market.

A number of directives can be chosen to acquire chosen policies. Such as; open market operations, altering the demand and supply of money in the economy as well as interest rate that in turn encourage or discouraging buying, selling and investment. Open market operations normally involve the Fed buying securities that have been issued to private investors. This enlarges reserve base whilst increasing abilities of depositary institutions to expand credit and money and make loans. On the other hand, the Fed may looks at the cost of credit and money by measuring interest rates relative to projections on the interest rates. The second option involves looking at how credit and money grow (Friedman & Kuttner, 2011). Hence, it is possible to judge current stance in monetary policies by looking at the supply of money and credit in an economy. Generally, the market rates are pegged on private markets for overnight reserves of banks and other depository institutions. Typically, these reserves can be traded overnight in the federal fund market. The interest rate in the market is what is known as the federal funds rate. In essence, the Fed uses this rate to conduct monetary policies. If the Fed wishes to expand it credit and money reserves then it will lower its target which shall in turn encourage lend activities and accelerate demand in the economy. In retrospect, the Fed must be ready to buy U.S securities so as to support the low target. Similarly, if the Fed wishes to condense its credit and money then it shall raise targets and eliminate reserves from banks as means to accomplishing it ends.  It’s undisputable that effective monetary policies can do much in the economy.

On the same line of thought it is worth pointing out on the need of relying on other policies such as fiscal policies that can also directly affect distribution of wealth and income. Altogether, if policy makers make appropriate use of aggressive monetary policies then job creation, economic growth and economic development would certainly be something that can easily achievable(Domanski et al., 2016).

References

Bullard, J. (2014). Income Inequality and Monetary Policy: A Framework with Answers to Three Questions. Speech delivered at the C. Peter McColough Series on International Economics, Council on Foreign Relations.

Domanski, D., Scatigna, M., &. Zabai, A. (2016). Wealth Inequality and Monetary Policy, BIS Quarterly Review (March).

Friedman, B & Kuttner, K. (2011). Implementation of Monetary Policy: How Do Central Banks Set Interest Rates?,” National Bureau of Economic Research, working paper, no. 16165.

Furceri, D.,  Loungani , P., &  Zdzienicka, A ( December 2016). The Effects of Monetary Policy Shocks on Inequality. IMF Working Paper. WP/16/245.