Tuesday, October 21, 2014

Catch-44: Janet Yellen, Inequality, Fiscal Policy, and Monetary Policy

On October 16, 2014, Howard Gleckman of the Tax Policy Center posted an insightful commentary on the declining budget deficit  ($483 billion, the smallest since 2009) for Fiscal Year 2014, which ended on September 30, 2014.

An improving economy, expiration of the Bush tax cuts, and expiration of the Social Security tax cuts all contributed to rising revenue.  One sentence especially stood out for your friendly proprietor:  "Revenues also rose because a growing share of income went to the rich, who pay higher tax rates.”  To repeat, the richer the rich get, the more revenue the government gets, hence a smaller deficit.  The path to a balanced budget, which some economists and politicians advocate, lies in the rich collecting a steadily rising share of income.

But in the eyes of many prominent economists, shrinking deficits are a problem.  In a world of zero interest rates, which means private sector spending and investment are not crowded out, deficits are constructive.  They can increase aggregate demand, which helps create jobs and halts stagnant or falling real wages for lower- and middle-income households.  Austere fiscal policy, declining deficits due to lower public spending (e.g., the sequester) and/or higher revenue, reduces aggregate demand, retards job creation, and suppresses wages.  Cost-imposed supply-side restrictions also retard growth.

Not only do smaller deficits suppress demand, the growing share of income going to the rich is increasing inequality.  This is incompatible with America’s core values, so said Fed Chair Janet Yellen on October 17, 2014.  In the second paragraph of a speech given at the Conference on Economic Opportunity and Inequality at the Federal Reserve Bank of Boston, she writes:

“The extent of and continuing increase in inequality in the United States greatly concern me.  The past several decades have seen the most sustained rise in inequality since the 19th century after more than 40 years of narrowing inequality following the Great Depression.  By some estimates, income and wealth inequality are near their highest levels in the past hundred years, much higher than the average during that time span and probably higher than for much of American history before then.   It is no secret that the past few decades of widening inequality can be summed up as significant income and wealth gains for those at the very top and stagnant living standards for the majority.  I think it is appropriate to ask whether this trend is compatible with values rooted in our nation's history, among them the high value Americans have traditionally placed on equality of opportunity.”

Paradoxically, it is Janet Yellen’s monetary policy of massive quantitative easing (QE), injecting new funds into financial markets by purchasing federal and mortgage backed securities, and low interest rates for those able to borrow (especially the already rich and wealthy), that has increased inequality.  QE boosts financial assets.  The DJIA nearly tripled from its bottom of March 6, 2009, through September 30, 2014.  Those with equities saw a huge rise in their wealth as new money fueled buying of equities.  Meanwhile, many in the middle- and lower- income brackets lost their homes (their chief source of wealth) and their jobs.

QE and zero interest rates may have helped the economy gradually recover from its deep hole caused by the financial crisis.  However, the chief beneficiaries have been the top 10%, 1%, and especially 0.1%.  Monetary policy has been the principle source of rising inequality of wealth and partly of income, with the highly educated and skilled earning an increasing share of income in the innovating economy.

Yellen’s monetary policy appears to be self-defeating when it comes to improving wealth and income equality

Yellen’s monetary policy appears to be self-defeating as rising tax collections reduce aggregate demand.

Is there an end to this Catch-44 circularity any time in her future?  Jobs remain a high priority in her conduct of monetary policy.  Yellen believes that QE and low rates help create jobs (trickle-down economics?) even though shrinking deficits may have the opposite effect.

Some 400 books have been written on the causes and consequences of the Great Financial Crisis, with little consensus on how to move ahead with growth, jobs, higher wages, greater equality, and, above all, prevent another crisis.  What’s Janet Yellen to do?  Pray for Congress to undertake an orgy of new spending, which is not in the cards, or that more money finally stimulates demand, growth, jobs, higher wages, and more equitable distribution of income and wealth.

I’m sure she would appreciate any good, non-ideological ideas you can send her.

Thursday, October 2, 2014