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Monetary policy and household inequality

ECB (2018), “Monetary policy and household inequality”, working paper series no. 2170, July

The impact of monetary policy, and specifically quantitative easing, on inequality has recently come to public attention. For example, commentators have pointed out that a prolonged reduction in policy interest rates can generate an income loss for savers holding interest-bearing assets, or that expansionary measures supporting financial asset prices are especially beneficial for the savers
holding those assets. This paper reviews theoretical findings on the distributional effects of monetary policy on households’ income, wealth and consumption and it provides suggestive empirical evidence on their quantitative relevance with special emphasis on euro area countries. The paper first points out that monetary policy, both of the standard and non-standard types, always produces distributional effects. Empirical evidence available for various countries suggests that a reduction in policy interest rates compresses the distribution of income. Regarding QE-type measures, an analysis focused on the four largest euro area countries finds that the Asset Purchase Program (APP) also led to a reduction of income inequality. The effect can mostly be ascribed to the disproportionately large drop in the unemployment rate of low-income households produced by the APP. However, the overall effects of monetary policy on income inequality are modest, compared to its observed secular trend. The mechanisms which can produce a heterogeneous impact of standard monetary policy on households are well-understood and can be grouped into two broad categories: direct and indirect effects. Direct effects are produced by changes in households’ incentives to save and in households’ net financial income. Direct effects can be heterogeneous across households depending, for example, on their net indebtedness. A reduction in policy rates will decrease interest payments for households with net outstanding debt, but it will also reduce interest income for households holding net financial assets. The indirect effect operates through the general equilibrium responses of prices and wages, hence of labour income and employment. After a reduction in policy rates, the direct increase in households’ expenditure and firms’ investment will lead to an increase in output and it will exert upward pressure on employment and wages. The additional increases in aggregate expenditure induced by higher employment and wages are the essence of the indirect effect. The indirect effect can also be heterogeneous across households to the extent that different sources of earnings—e.g., employee income vs. income from private businesses—or different pools of unemployed workers—e.g., low vs. high skilled—display different elasticities to the change in aggregate expenditure.

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