The Fed’s been keeping the economy afloat. That’s the problem.

May 29, 2013

The U.S. economy, as I wrote yesterday, seems to be holding up well despite the onset of fiscal austerity. Jared Bernstein, Scott Sumner  and Ezra say I should have mentioned an  important reason: the apparent success of the Federal Reserve’s policies, introduced last September, of pumping more money into the economy and pledging to keep rates low even after the economy improves.

They’re right! But that may not be a good thing.

There is good reason to think that monetary easing is doing quite a bit of the work offsetting tighter fiscal policy. The Fed’s policies, including buying $85 billion in bonds each month with newly created money, are directly aimed at housing; $40 billion of those purchases are of mortgage-backed securities, meaning the money is being funneled directly toward the sector. And sure enough, a solidifying housing market is an important part of the economy’s holding up. And a second important consequence of Fed easing is to boost the prices of other financial assets, including the stock market.

This isn’t rocket science: The Fed in September introduced a policy meant to boost housing and stock prices, and now, nine months later, housing prices and stock prices have risen quite a bit. Enough, indeed, to (so far) offset the impact of higher taxes that went into effect Jan. 1 and federal spending cuts that took effect March 1.

So far so good. The bad news, though, is that these channels through which monetary policy affects the economy tend to offer the most direct benefits to those who already have high incomes and high levels of wealth.


Source: Federal Reserve

Data from the Fed's Survey of Consumer Finances shows that nearly half of families in the upper 10 percent of income own some stocks, and that of those who did the average value of the portfolio was $489,000 in 2010. (It was over $650,000 in 2007, and now that stock prices are back to 2007 levels, it's a reasonable guess that the 2013 number will turn out to be in that ballpark).

Among middle-income people, only 11.7 percent own stocks. In the bottom quintile, only 3.8 percent own stocks. The stock market rally of the last few months is having the most direct benefits for those who already are comfortable; middle- and lower-income people are only benefiting from the second-order effects, such as higher stock prices leading businesses to become more confident and thus invest in expansion, and wealthy people, now wealthier, spending more money and hence creating general demand across the economy.

The home price rally — the S&P/Case-Shiller home price index is up 10.2 percent in the year ended in March — has broader benefits, but they are still concentrated at the upper end of the income spectrum.


Source: Federal Reserve

As the chart shows, homeownership is high among everyone from the 50th percentile of wealth and above, suggesting that the benefits of the home price rally are being felt more broadly than the stock price gains. But that still leaves the bottom half: Only 61 percent of people in the 25th through 50th percentile of wealth own a home, and 22 percent in the bottom quartile.

Again, that doesn't mean that the housing resurgence isn't a good thing for the working class; home prices should coax builders to start constructing more houses, and they'll need to hire workers to do that work, which should create job gains in a sector where jobs have been sorely lacking for the past several years. But it is, once again, a second-order benefit for the average Joe.

And while the economic gains from Fed easing have had their first-order benefits for middle- and upper-income families, the economic losses from fiscal austerity have, in many cases, had their first-order effects on the poor. As Brad details, budget cuts due to sequestration have hit Head Start programs, federal housing programs and unemployment insurance benefits particularly hard. (In fairness, some of the fiscal tightening has affected upper-income people more heavily, most notably an increase in the marginal tax rate on households making more than $450,000 — from 35 percent to 39.6 percent — that went into effect Jan. 1).

Still, put it all together, and an expansion like this one, driven heavily by Fed monetary easing, is better for those who are already doing well than would be the case if fiscal policy were driving the recovery train.

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Dylan Matthews | May 29, 2013