U.S. primary elections this week proved yet again that public opinion is both poisonous and punishing. There are a lot of reasons for this, perhaps the most important of which is the fundamental fact that – eight years after the financial crisis and despite trillions in unprecedented accommodative monetary policy – the rich are richer and the poor are, if not always poorer, still pretty peeved. The Federal Reserve Board would doubtless say that it’s done everything it can to avert income inequality – indeed, Chair Yellen has called this a serious national challenge much to the consternation of Congressional Republicans. However, a little-noticed BIS study we assessed earlier this week for clients argues that central banks are at least as much a part of the problem as over-austere fiscal policy and the broader forces of social change. Banks may think they can duck and cover as the FRB takes the income-inequality assault, but the first shells fired are likely to be from those arguing that IOER is a big-bank subsidy that would be better spent on themselves.
To be sure, IOER – interest on excess reserves – is only a side note in the BIS study. Its fundamental focus is on the way post-crisis policy has swelled equity prices – assets of the rich – with far less of a boost evident in the housing prices that form the principal source of wealth for lower-income individuals.
Still, the study finds that the financial crisis has coincided with spikes in inequality above and beyond underlying pre-crisis trends, with rich households getting richer in the U.S. four times faster than poorer ones. Interestingly, Germany shows the most significant impact of deposit holdings for income inequality purposes, with the survey finding ultra-low German interest rates a driving force for heightened inequality due to Germany’s high savings rate. NIRP lovers, take notice – for all that Larry Summers loved the ECB’s decision yesterday to hit the panic button, he may not be pleased with the NIRP social-welfare impact.
How does this affect IOER? The BIS paper did not generally focus on non-traditional monetary policy, looking instead largely at the effect of changing interest rates on asset-acquisition incentives and resulting returns. But politics has little to do with this second-level analysis. What we know is that U.S. income inequality is rising. What the BIS paper suggests is that monetary policy may play an inadvertent role in exacerbating this.
What some then will think is that central banks are for the rich, big banks are for the richer, and that money that flows from the FRB largely to big banks is theirs. Chair Yellen tried to rebut this before Congress by arguing that the FRB gives the banks less in interest than it takes in on its big book of QE-acquired assets, but all this tells populist critics is that the FRB gets the biggest share. Sure some of this goes to the Treasury’s bottom line, as Ms. Yellen also said, but working one’s way through this net-interest margin chain requires analytics with which no one who doesn’t like either banks or the Fed is likely to trouble.
Would Donald Trump scruple at calling for wholesale FRB reform that forces IOER to short-circuit? It isn’t his money. Would Bernie Sanders worry? In his view, it’s our money, so go for it. Secretary Clinton, Gov. Kasich, or others might scruple at eviscerating the central bank’s capacity to get itself out of its QE jam, but they might not get a chance to comment if Congress gets into this complex, dangerous, and all-too-appealing act. Fundamental redesign of the FRB takes time, but taking money flowing from the FRB to banks is remarkably easy, especially if the current hang-them-from-the lampposts fury rages unabated on through November.