Monetary Policy for all? Inequality and the Conduct of Monetary Policy
IMF Blog, September 30, 2020
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Bibliographic details
- Authors: Niels-Jakob-Hansen, Alessandro Lin, Rui-Mano
- Published: September 30, 2020
Context and research question
- Publication: Niels-Jakob Hansen, Alessandro Lin, Rui C. Mano — September 30, 2020
- Problem: Inequality in advanced economies and emerging markets has risen in recent decades and has been exacerbated by the COVID-19 pandemic.
- Central question: What role can the central bank play in addressing inequality given that fiscal policies and structural reforms are already powerful mitigators?
Theoretical framework and model setup
- Economy: Stylized model where business cycles are driven by innovations in technology.
- Agent types:
- R (rich): owns all capital; income composed of after-tax dividends and wages.
- P (poor): receives only wages and a government transfer financed by the dividend tax.
- Mechanisms highlighted:
- Positive productivity shocks raise profits and capital income, thereby exacerbating inequality.
- Wages are tech-biased: when productivity rises, R’s share of total wage income goes up while P’s share declines.
- Empirical consistency: These mechanisms are stated to be consistent with U.S. micro- and macro-economic data and match empirical effects of technology shocks on consumption inequality.
- Inequality measure used: difference in consumption between rich and poor.
Policy environments analyzed
- Setting 1 — Optimal policy:
- Central bank chooses the best possible path of interest rates with full information and cares equally about all individuals.
- Setting 2 — Taylor rule:
- Central bank sets policy according to a Taylor rule prescribing interest rates based on deviations of inflation and output from desired levels; this setting is closer to actual central bank practice.
Key findings — Optimal policy (Setting 1)
- The central bank should place some weight on observed consumption inequality.
- Policy action: Lower interest rates to stimulate growth and wages, thereby reducing consumption inequality, while tolerating inflation moving above target.
- Magnitude: The weight on inequality is generally small; output and inflation are not substantially different from those under a policy that ignores inequality.
- Behavioral shift with higher initial inequality: A central bank pursuing optimal policy cares progressively less about inflation and more about growth the higher the initial level of inequality.
- Rationale: With higher initial inequality the central bank works harder to stabilize wages and protect the consumption of the poor; stabilizing wages coincides with stabilizing growth.
Key findings — Augmented Taylor rule (Setting 2)
- Recommendation: Augment the Taylor rule to target consumption inequality in addition to output and inflation.
- Policy action after a positive productivity shock: Set interest rates lower than implied by a standard Taylor rule that targets output and inflation alone.
- Effects:
- Lower interest rates raise wages, benefiting the poor and lowering inequality.
- Beyond distributional gains, this policy improves inflation and growth outcomes by avoiding excessive tightening in response to a positive productivity shock.
Overall implications and caveats
- Welfare: Results suggest welfare could be improved if central banks take inequality into account when conducting monetary policy, particularly when following typical interest rate rules.
- Model specificity: Results are model specific and can be complemented by extensions such as including differentiated types of labor and differentiated wages, or a richer set of available assets.
- Research agenda: Findings bolster the case for more theoretical and empirical work on the interplay between monetary policy and inequality.
Source: Monetary Policy for all? Inequality and the Conduct of Monetary Policy — Niels-Jakob Hansen, Alessandro Lin, Rui C. Mano, September 30, 2020.