Engine of Inequality. Karen Petrou
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that inaction, an answer made still more angry and urgent by America in the wake of the pandemic. If more small businesses had been able to access sound credit before COVID, then many fewer would have closed and many more lower-income jobs would have survived. If most Americans had been able to put aside some savings, then families wouldn't have run to food pantries in still-untold numbers. If policy-makers had seen the extent to which the Fed's vaunted recovery stopped far short of people and businesses of color, then the fury following George Floyd's murder would have focused solely on racial justice, not also on demands to “eat the rich.” If financial institutions – not just banks – had been properly regulated, then Americans wouldn't have been so deeply in debt and the financial system wouldn't have crumpled the first day COVID's force was felt. And if the Fed hadn't immediately rushed in to rescue all this risk-taking, then Americans of wealth wouldn't have become so much richer so much faster even as US unemployment numbers reached heights not seen since the Great Depression.
Economic inequality is not a curse that afflicts America because some people just don't try hard enough or even because some politicians just don't care enough. This book – the first to do so – will show that US income and wealth inequality grew worse faster than ever before after 2010 due to the one thing that dramatically changed that year: the way the Federal Reserve set monetary and regulatory policy. As you will see, there is a clear and causal connection between financial policy and economic inequality and breaking it is desirable, feasible, politically achievable, and meaningful as a near-term equality remedy.
It might seem fanciful to target financial policy – after all, most of us don't even follow financial policy, let alone feel its impact in our daily lives. However, the interest rates we get at the bank or pay on our debt, the returns some of us achieve in the stock market, the financial companies we choose or are forced to do business with, and even the wages we get are the result of financial policy. As a result, financial policy controls key turbines in the inequality engine.
Financial policy is the combination of the monetary policy dictated by the Federal Reserve Board and the rules written by the Fed and financial regulators. Although ignored by most assessments of economic inequality, financial policy sets the speed and direction of the inequality engine because the inequality engine's fuel is money and no policy moves money with more force than financial policy. When the US economy largely depended on manufacturing and agriculture, financial policy moved the inequality engine, but only a little in comparison to other causes of American economic inequality such as tax or trade policy. But when an economy is “financialized” – i.e., when growth depends in large part on financial activities, not real production – financial policy is an inequality engine unto itself. The US is a financialized economy and financial policy is thus a potent inequality force.
In the US, money thus moves where monetary and regulatory policy drives it. And ever since the great financial crisis, policy drove money to take ever more speculative bets in financial markets that know neither risk nor bounds thanks again to financial policy. How could it have been that, the day in April 2020 that the US announced then-record COVID deaths, the S&P 500 finished its best week since 1974? As this book will show in detail, one need look no farther than the Fed, which that day also stepped in with trillions to backstop even the riskiest investments.
It's thus clear that money determines an economy's haves and have-nots, but how does the inequality engine powered by money work? First, the engine analogy encapsulates the lesson in the Gospel of St. Matthew: “For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath” (Matthew 25:29).
This scriptural injunction is in a parable some scholars read as an assessment of spiritual growth, but it aptly describes the critical finding in Thomas Piketty's magisterial analysis of economic inequality:3 when financial rates of return are above that of broader economic growth, inequality speeds up in a cumulative way, just like a gassed-up engine driven by someone with a heavy foot on the pedal.
The second reason to think of inequality as a financial-policy engine is that it helps us reckon with the critical importance of taking actions that put it into reverse or even turn it off. Letting an engine continue on its course even though the course is wrong only gets us farther from our goal at speeds set ever faster by the engine's cumulative force. To make a difference in inequality, we thus need to pick policies that make a difference as quickly as possible.
This book thus not only details how financial policy made America increasingly unequal faster and faster, but also lays out changes we can make to the engine under current law with remarkably little controversy that will quickly slow the engine and recalibrate its direction toward renewed economic equality.
Much inequality thinking proposes far grander repairs, but most are controversial, costly, and – most importantly – slow-acting. For example, reforming the nation's educational system is indeed an important inequality fix, but it will take years before kids in a better primary school graduate from institutions of higher education and decrease family inequality. We can't wait that long.
Because inequality is an engine with cumulative force that chews up low-, moderate-, and even middle-income families, meaningful solutions must not just be fast-acting, but also politically plausible. Changes to US fiscal policy – i.e., to taxation and spending – such as a “wealth tax” or “guaranteed income” are appealing to some in macroeconomic and social-justice terms but face long, long political odds. Financial-policy fixes to the inequality engine aren't always optimal, but practical policy solutions to income and wealth inequality slow down the inequality engine and give us time also to make more profound structural repairs.
So, what are these fast-acting, politically plausible, and high-impact financial-policy fixes? The first recrafts US monetary policy so it sets interest rates at levels I call a “living return” and retracts the Fed's safety net from beneath financial markets. Ever since the mid-2000s, the prime directive of US monetary policy is what the Fed calls the “wealth effect,” which as its name clearly implies assumes that the wealthier a few people get, the more money trickles down to the rest of us. The wealth effect worked in one sense – wealth has grown to prodigious heights in fewer and fewer hands – but it's done nothing for broader, shared prosperity. This book thus posits a set of monetary-policy actions premised on an equality effect derived from ground-up Fed interventions, not top-down largesse.
You'll see that one reason the Fed thought the “wealth effect” created a “good place” is because the Fed measures America as it was decades ago, not as it now is. When it measured employment, the Fed missed the millions holding only part-time jobs or those out of the workforce due only to lack of hope, not lack of desire to work. The Fed said that American households had growing wealth, but it ignored the fact that most of this wealth was held in fewer and fewer hands. Wage gains in which the Fed took pride resulted from more people in more families having to work more jobs, not from higher wages allowing one wage-earner to support his or her family in reasonable comfort as many of us assumed when we were kids.
And the Fed missed the fact that most American families lived paycheck to paycheck, making ends meet only via high-cost debt. The central bank touted its ultra-low interest rates as a boost to the wealth effect, but all they meant to the vast majority of American households was no hope of saving for the future. Most of the debt they used to get by also remained very, very expensive.
As we'll see, this high debt burden, combined with the challenges to robust employment, hit America hard when COVID pulled the rug out from under all the Fed's mistaken expectations. Still, when the pandemic struck, the Fed created two huge facilities to backstop giant corporate debt and opened a “Main Street” bank that in fact did business with companies able to repay loans greater than $250,000 because their annual revenues were as much as $5 billion. The Fed could and should instead have opened a Family Financial Facility that provided ground-up – not trickle-down – emergency economic support.
However, it's not enough for the Fed first to fix monetary policy based on a true reading of America's unequal economy and also to aid those truly in economic need under acute stress. We