The Fed’s New “Gain-of-Function” Monetary Policy
By Scott Bessent
Overuse of nonstandard policies, mission creep, and institutional bloat are threatening the central bank’s monetary independence….In her book Engine of Inequality: The Fed and the Future of Wealth in America (2021), progressive financial policy expert Karen Petrou documents how the Fed’s pursuit of a “wealth effect” to stimulate the economy backfired. “Unprecedented inequality,” wrote Petrou, “is clear proof that the wealth effect is all too effective for the wealthy, but an accelerant to economic hardship for everyone else.” Economists’ focus on the supposed benefits of the wealth effect is particularly odd given that the Fed’s asset purchases act more powerfully on the discount rate at which assets are valued than the stream of cash flows that underpins the asset’s price. Asset owners are less likely to bring forward consumption as a result of changes in the discount rate than income growth, and to the extent that they do increase consumption, the effects may reverse once discount rates are normalized. In Petrou’s view, the exacerbation of income and wealth inequality is a function of the distribution of assets in the United States—which the Fed should take as a given. Only the very wealthiest individuals own financial assets that are most directly impacted by the Fed’s large-scale asset purchases. Moving down the spectrum, a substantial portion of the middle of the income distribution has exposure to home equity, but this asset is less sensitive to the Fed’s financial market machinations. The bottom 50 percent of the income distribution, however, has very little net wealth, “derived mostly from automobiles, not from other durable or financial assets that hold or gain value over time.” As a result, the natural consequence of the Fed pursuing the wealth effect is actually to compound the wealth of the most fortunate members of our society. Additionally, Petrou points out that the Fed’s habit of riding to the rescue of financial asset owners has effectively corrupted the disciplining role that financial markets are supposed to play in the economy. As a result of successive Fed interventions, Petrou noted that one famous investor wrote, “Financial markets have come to expect the Fed to intervene in response to any sharp declines in equity prices.” This situation, wrote another commentator, effectively set up a situation of “socialism for investors, capitalism for everyone else.”