III Money and monetary regimes

Central banking and income inequality: The impact of monetary policy on income distribution


Since the 2007-2008 Global Financial Crisis, income inequality and income distribution matters have gained increasing attention not only in academia but also from professionals in advanced economies. Mainstream economists also joined this concert, with Piketty’s famous work, Capita! in the 21st Century (2014). This income inequality has been rising since the early 1980s. Since 2010, median family incomes have fallen, while the mean has risen. Inequality keeps rising. A Morgan Stanley study, carried out in 2014, has also identified the rise in inequality, due to the growing proportion of poorly paid and insecure low-skilled jobs; the rising wage premium for educated people; and the fact that government (tax and spending) policies are less redistributive than they used to be a few decades ago. In that same year, a report was written by the chief US economist of Standard & Poor’s, and another from Morgan Stanley, agreeing that inequality is not only rising but having damaging effects on the US economy. Janet Yellen, the chairman of the FED, recognised in her 2014 speech the growing gap between the rich and the poor, and she highlighted the risk of increasing income inequality to the American economy. However, concerns of inequality as a socioeconomic matter remain very limited among mainstream central banks. This is because Mainstream Economics views inequality as an outcome of a capitalist economy. In contrast, post-Keynesian economics see it as an inherent component of capitalist economy.

This chapter discusses inequality from a central banking perspective, debating inequality and causes and consequences from mainstream versus post-Keynesian perspectives. The main focus will be on the view of the interest rate as a distributive variable, highlighting what is called the fair rate of interest, ‘Pasinetti’s rate’, as an alternative policy rate to tackle income inequality. However, a fair rate of interest by itself does not solve the inherent inequality, it should be combined with different measures, notably with fiscal policy through a long-term public investment that ensures that the unproductive rentier class disappear as Keynes wished. Thus, central banks as a public entity should essentially take responsibility to promote social justice and fairness, not only for the current generation but for the next one as well. The key argument presented is that central banks, because of their pivotal position between the government, the banking sector, and society, should take responsibility for the fight against increasing inequality instead of only focusing on the nominal anchor of inflation targeting. The importance of the fair interest rate, compared to other alternative interest rates, is that the one that maintains purchasing power in relation to labour hours and money borrowed or lent, maintains the distribution of income between borrowers and lenders over time. From the fair rate perspective, central bank inflation targeting, as currently practiced, is not distributionally neutral in that it enables the capitalist class to take favourable financial positions.

The chapter illustrates that if the central bank incorporated a ‘fair rate of interest rule’ it would reduce inequality by distributing income from the rentiers class to other productive classes. That is consistent with Keynes’ policy recommendation against the unproductive rentier class.

This chapter discusses inequality from a central banking perspective. First, inequality will be defined, as inequality could take different forms. The section that follows will discuss how central bankers view inequality, causes, and consequences. That is mainly drawn from a mainstream perspective. The third section will follow a post-Keynesian approach to inequality causes and consequences in a modern financialised economy. Then the fair rate on interest will be discussed as a solution. Finally, a conclusion will be drawn.

Definition of inequality

Rising inequality has recently become a major concern in advanced economies, as not only does it affect economic activity but it also affects social justice and fairness. Inequality could take different forms in a modern capitalist economy: inequality of wealth, income, financial exclusion, race, gender, globalisation, technological progress, education, and more importantly institutional set-up of our society. Inequality matters as it not only impacts upon our society today, but it also has a long-run impact on the next generation.

Usually, mainstream studies focus on quantifying and simplifying inequality to limited and straightforward scope, such as wealth inequality, income inequality, opportunity inequality. However, social justice, holistic well-being, and morally problematic issues are ignored. For instance, should we care about inequality in well-being, in social primary goods (Rawls, 1999), capabilities (Sen, 1992), opportunities, or some other relevant domain? For instance, Piketty (2014) has justified that the current levels of inequalities are unjust in themselves.

According to Fontan et al. (2016), some recent theorists of justice suggest that what is relevant for justice is some measure of the means, resources, or capacities of the individual to pursue her life plans rather than the actual welfare level she attains (see, for example, Dworkin, 1981). For example, inequalities in income or wealth are more straightforward to ascertain than

Central banking and income inequality 143 inequalities in opportunities or capabilities. Further, egalitarian theories of justice, in particular, have become more sophisticated than a simple call for equality in outcome. As a result, general claims about justice tend to focus on the inadmissibility of certain kinds of inequalities rather than call for outright equality (Fontan et al., 2016). For instance, the notion of equality of opportunity implies that people of equal talent should have equal opportunities or, put differently, that one’s social background should not have any differential impact on one’s life prospects. Second, we might employ Rawls’s difference principle, which, as standardly understood, requires that institutions ensure inequalities in income and wealth maximise the expectations of the least advantaged (Rawls, 1999). Third, prioritarian views argue that we should be sensitive to both the ‘size of the cake’ and the interests of those who receive the smallest slice, but without imposing a strict constraint as a maximum threshold (Parfit, 1997). Given its structure, prioritarianism promises to be particularly useful when it comes to trade-offs between containing inequalities and promoting economic growth. Other theories such as sufficientarian approaches view that what counts is not what people have relative to others, but that they have enough. The advocates of the sufficientarian approach aim to establish a minimum threshold of the currency of justice in question that everyone should attain (for example, Frankfurt, 1987; Casal, 2007).

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