The Washington PostDemocracy Dies in Darkness

Opinion The Fed has an irresistible equity itch

The Federal Reserve Board building in Washington in March 2019.
The Federal Reserve Board building in Washington in March 2019. (Leah Millis/Reuters)
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“The very first requirement in a hospital [is] that it should do the sick no harm.”

Florence Nightingale

When the Federal Reserve was created in 1913, long before it aspired to be a fourth branch of government, its sufficient mission was to preserve the currency as a store of value: Price stability facilitates economic dynamism by giving economic actors a degree of certainty. In 1978, Congress encouraged institutional imperialism in the Fed by mandating that its policies should promote “maximum employment.” Ben Bernanke, the Fed chair from 2006 to 2014, construed this as a single capacious mandate for “promoting a healthy economy.” If so, the mandate excludes nothing.

Now, it seems, the Fed feels an irresistible itch to participate in every important government policy endeavor. The Fed (and some other central banks and international financial institutions) seems disposed to weigh “climate risk” in its decisions. Which implies that climate change poses a knowable near-term risk to the financial system. This is, to say no more, implausible.

John Cochrane of the Hoover Institution at Stanford University suspects that a climate risk responsibility will encourage banks “to make up numbers in order to justify de-funding politically unpopular fossil fuel projects.” This is a dubious undertaking for government, and a weird function for a central bank.

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In 2020, Joe Biden said the Fed should “aggressively target persistent racial gaps in jobs, wages and wealth.” If so, the Fed’s newest mandate is Washington’s word du jour, “equity.” This word implies, without defining, a social outcome different from — and superior to — the equality affirmed in the Declaration of Independence and the Constitution’s guarantee of equal protection of the laws.

The Fed’s economists, who had better be polymaths, must now plunge monetary policy and financial regulation into the political and philosophical challenges of pursuing social justice. (Can anyone explain how the adjective modifies the noun?) First, however, they should read the Federal Reserve Bank of New York’s reportMonetary Policy and Racial Inequality.” If racial equity means less racial inequality in incomes and wealth, the Fed faces a conundrum: The monetary policy it thinks the nation needs now and for the foreseeable future (the Fed did not foresee 2008 in 2007, or the economy’s current strength four months ago) is harmful.

The Fed indicates that, until at least 2023, interest rates will remain near zero. (This is, in Fed-speak, “accommodative monetary policy.”) The New York Fed’s report says: Very low interest rates increase employment of Black households more than of White households, although “the overall effects are small.” Low interest rates, however, substantially exacerbate Black-White wealth differences.

Low rates stimulate the economy, drawing marginal workers into the labor market, and a tight labor market pushes up wages. But low rates also cause money to flow into assets such as stocks and houses in search of higher yields. But “the median black household has no stock holdings, nor owns a house,” so “accommodative” policy “bypasses the majority of black households.”

Over a five-year period, this policy causes the Black unemployment rate to fall by about 0.2 percentage points more than the White unemployment rate, but the policy increases stock prices by as much as 5 percent and house prices by 2 percent. And if it increases inflation, this disproportionately burdens low-income groups that devote larger portions of their incomes to consumption.

In 2019, the median wealth of White households was $184,390, and $20,730 for Black households. This ninefold wealth disparity dramatically exceeds the 1.7 times larger income disparity favoring Whites. The stock market boom of the 1990s, the New York Fed’s report says, provided a large boost to average White wealth but a negligible impact on average Black wealth.

White households, with high wealth-to-income ratios (in 2019, they owned 8.6 dollars of wealth per dollar of income; Black households owned 2.5 dollars of wealth per dollar of income), benefit from the asset price increases resulting from accommodative Fed policies. This is the distribution of the gains from accommodative monetary policy: “About 80 percent of all gains accrue to households in the top 5 percent of the wealth distribution and about 50 percent go to the top 1 percent. Notably, this distribution is substantially more unequal than the distribution of wealth itself.”

The New York Fed’s report says that although “the distributional effects of monetary policy” are “outside central banks’ formal mandates, central bankers are increasingly discussing distributional issues.” When they are not discussing climate risks, and much else. Including, one hopes, what nurse Nightingale knew.

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