How do monetary policy and inequality impact each other? 

Together with Positive Money Europe and the Council on Economic Policies we assembled representatives from civil society, academia and the central banking community at a workshop in Brussels to discuss how monetary policy impacts inequality in Europe. Read the summary below.

For a long time this topic was not on the agenda. However, the wider social impact of monetary policy was made evident in the broader public by the, for example, sharp rise in real estate and other asset prices during the low interest rate period of the last decade, and also more starkly by the impact of high interest rates on the costs of living since 2022. But is this relationship as simple as it seems? 

One overarching take-home message of the workshop was that inequality can be looked at with different lenses. It was suggested that distributional effects in terms of various social groups might be difficult to disentangle: should we be looking at age, gender, and race, for example, next to income and wealth distributions? In addition, monetary areas, such as the eurozone, might consider cross-country, as well as the within-country inequalities as highly relevant. Only after establishing these can we start determining the impact of monetary policy on distributional variables. For instance, accommodative monetary policy might reduce inequality in for one group on one measure, but increase it for another. These effects get even more complicated when unconventional monetary policy is added to the mix. 

The bulk of the workshop was dedicated to empirical research. One finding presented was that inequality rises and persists after financial crisis, but also that higher inequality makes crises deeper in the first place. As tax policies became less progressive and automatic stabilizers have been weakened since 1980s, more has been expected from monetary policy to address the distributional issues. However, inequality presents specific issues for monetary policy too. A relevant empirical finding was that in more unequal societies, loose monetary policies have less of an expansionary impact on consumption and income levels.  

Another strand of research was looking into the distributional impact of the 2022 inflationary shock, as well as this impact of mitigative fiscal (income and price) policies in selected EU countries. The research broadly shows that the inflationary shock was considerable and affected lower income deciles disproportionately more. Another finding was that fiscal measures were, on the whole, not particularly successful in reducing this impact for the groups in the lowest deciles. Further research will disentangle the distributional impact of the monetary policy response to the inflationary shock.  

Lastly, we learned about different dimensions of wealth distribution in Belgium. The results show that Belgium fares more favorably than the eurozone average on several relevant parameters. Moreover, looking at the richest 10% metric makes Belgium one of the least unequal OECD countries in terms of wealth inequality. Some of the reasons for this are the less sharp increase in property prices in Belgium, as well as relatively high percentage of homeownership, relative to other euro area countries. However, on the whole, wealth inequality is rather considerable, which could be relevant for central bankers. For instance, interest rate change could be sub-optimal due to heterogeneity in the propensity to consume across income and wealth distribution. Also, to the extent that excess savings were invested in risky assets, a higher share of these could lead to financial instability.  

A legal contribution to the workshop assessed the ECB’s legal standing with regards to acting on distributional issues. A suggestion to use the secondary objective and Article 8 of the Treaty (“EU shall aim to eliminate all inequalities in its activities”) might be considered better as only a supportive argument, since it might not have favorable standing with the EU courts. A better way to interpret the role of inequality in the ECB mandate would be through the so-called instrumental view: inequality should be considered to the extent that it helps the ECB fulfil its price stability objective. This could have better legal standing with the ECJ at least, who previously have the ECB broad leeway in interpretation of the preconditions towards achieving its primary objective.  

Another light on the topic was shed by the historical overview of the evolution of central bank independence and the theoretical arguments leading up to it. It shows that the fears of wage-price spirals taking place in the 1970s were highly relevant for the thinking behind formulating the idea of central bank independence. According to the authors, this fear is still present in the ECB thinking, as shown by the analysis of speeches of its officials, where the appearance of the term “wages” is much higher than that of “margins” and “profits”. This did not change even in in the recent inflationary shock where the contribution from wage increases was smaller than the corresponding profit share, as recognized by the ECB statistics. Instead, speeches from officials show that the main concern was the growth in aggregate demand, i.e. reducing the bargaining power of workers for wage increases. The authors conclude that the distributional issues of fighting inflation are inherently political, as inflation itself has clear distributive consequences, and that a European Credit Council could be introduced that would enhance the cooperation between central banks and politicians and guide the ECB’s secondary objectives, while maintaining its operational independence. 

The main takeaway from the workshop was that the topics of climate – which SFL has worked on actively — and inequality, with regards to monetary policy, cover a lot of the same ground, but also differ in key respects. On the one hand, considering the ECB’s mandate and the role of both of these topics is key for future research. Relatedly, the role of central banks as independent agents is highly relevant for both addressing climate change and distributional matters. Also, more theoretical research needs to be done in both areas. On the other hand, and on a more practical side, introducing climate consideration in central banking includes, among other things, adjusting monetary policy instruments. It is not clear that a similar tactic can be applied to the distributive issues. One conclusion drawn from the workshop is that these would need to be tackled in a more structural way, possibly taking fiscal policies into consideration. We are looking forward to further research in this field, learning from helpful contributions by all stakeholders in the workshop.