Inequality is growing across the West and it has been since at least 2008. Why is this happening, how does it affect society and what can be done to stop it? Here are my views and ideas on the subject.
Inequality seems to me to be the result of having different taxation for labour and capital coupled with the extensive use of experimental monetary policy the gains from which unproportionally goes to those already well off. I’ve written before about Quantitative Easing (QE) but it’s a topic worth going back to as it has had a profound effect on the era we find ourselves in. The broader economics and the politics of an extended period of time with low interest rates are interesting but for the purpose of this blog post we’ll mainly focus on the effects that near zero interest and large-scale government bond purchases has on inequality. This blog post will explain how QE exacerbates inequality between socio-economic classes and between generations through the wealth effect and the portfolio rebalancing effect that some central banks have stated to be the goals of their QE programmes. This argument deals a fair bit with bonds but the main issue is the way QE affects the housing market.
The stated objectives of QE are mainly twofold, creating a portfolio rebalancing effect and a wealth effect. A portfolio rebalance is when an investor reconsiders the relative weights of different asset classes in their portfolio. An asset class in this context is for example bonds or stocks or real estate. By buying up safe government bonds the central bank can lower the percentage yield on bonds as the pay-outs from a bond are constant whereas the price fluctuates. If a central bank prints money which it uses to buy a lot of government debt it drives up the price of government debt which lowers yields which makes bonds relatively less interesting as an investment compared to other asset classes. What’s the benefit to a portfolio rebalancing effect? Why does it matter that investors hold stocks or corporate bonds rather than government bonds? Well, when investors invest in corporate bonds or stocks it makes it easier and cheaper for those firms to raise funds through capital markets making it cheaper and easier to invest in large projects. This is meant to incentivise large corporate investments like building new factories thus hiring more people and therefore driving up aggregate demand through the multiplier effect. The wealth effect is the idea that by raising government bond prices those who own government bonds become wealthier and can thus spend more which once again drives up demand through the multiplier effect.
The way the focus on the wealth effect can exacerbate inequality fairly straight forward. Those socio-economic classes which own government debt are generally quite wealthy as it is and don’t need the central bank’s help whereas those classes which don’t tend to afford to invest would most likely be more inclined to spend their new wealth if they were the ones to get help from the central bank. The portfolio rebalancing effect also benefits the more well off in society by most of the same mechanisms as the wealth effect. By forcing bond yields down the central bank incentivises investors to shift to riskier assets such as stocks or real estate which puts upwards pressure on the prices of stocks and real estate which benefits those who already owns those assets. It’s worth diving a little deeper in to the housing market here as QE exacerbates inequality across both classes and generations when it comes to real estate. As described real estate prices increase at the same time as interest rates are almost at zero which makes it cheap to borrow to invest in real estate. This is a problem for other asset classes too but the effects are more important in the case of houses and apartments as they have obvious practical uses besides their uses as investments. Furthermore borrowing to invest is risky and if you’re going to use leverage you’d want your investment to be safe as houses (pardon the pun). If yields on real estate are good then buying to let is a good investment which greatly disfavours the young and the working class who will find it more difficult to buy and more expensive to rent which makes it more difficult to save up to buy in its own right.
If you found this blog post interesting consider recommending it to a friend and click here to read my other posts on economics and political economy. What are your thoughts on the subject? Please leave any responses in the comments or on Twitter @ipolecoblog.
Photo by David McBee from Pexels
Comments