Prepared by Maarten Dossche, Jiří Slačálek and Guido Wolswijk
1 Introduction
- During that period, the increase in unemployment, the heterogeneous evolution of house and stock prices, and the fall in interest rates all affected households in very different ways.
- [1] More recently, there has also been a greater focus on the interaction between monetary policy and inequality.
- [4] This article reviews the latest evidence on economic inequality and its interaction with monetary policy, with a particular focus on the euro area.
- Section 4 looks at how heterogeneity in household income and wealth affects the transmission of monetary policy to household spending.
- And Section 5 summarises the implications of these findings for monetary policy, as well as considering a number of aspects that require further research.
2 Analysis of trends and cycles in inequality
Secular trends in income and wealth inequality
- We can see that income inequality is substantially higher in the United States than it is in the European countries in that chart.
- By contrast, the three Nordic countries (Finland, Norway and Sweden) have relatively low levels of income inequality.
- It is also noticeable that only one country Spain saw a decline in income inequality over the period in question.
Chart 1
(percentages)
- Income taxation and government transfers have a dampening effect on income inequality, with the precise nature of that impact varying across countries on the basis of their tax systems.
- If we compare the distribution of disposable income with that of market income for the four largest euro area countries, the United Kingdom and the United States (Chart 2), the dampening effect of direct taxation (e.g.
- via progressive income taxes) and transfers is evident.
- However, it is not clear, a priori, to what extent the higher degree of redistribution in Europe can explain the more limited increase in income inequality in the European countries in question (as shown in Chart 1).
- Two recent studies concluded that the difference between Europe and the United States in terms of the increase in income inequality is driven mainly by market income i.e.
Chart 2
Reduction of Gini coefficients through governments’ direct taxes and transfers (Gini coefficients)
- Consumption is substantially less concentrated than net wealth, which may suggest that economic well-being is more evenly distributed than wealth.
- Consumption inequality is sometimes regarded as a better indicator of the standard of living and welfare than income or wealth-based measures.
- [7] As Chart3 shows, the Gini coefficient of consumption expenditure is typically lower than that of disposable income, reflecting the fact that higher-income households have a higher saving rate.
- [8] The Gini coefficient of net wealth, which is defined as assets (housing, deposits, bonds, equity, etc.)
Chart 3
Gini coefficients of disposable income, consumption and net wealth (Gini coefficients) Sources for panel a: Standardized World Income Inequality Database, versions 8 and 9 (net income), for the United States; World Income Inequality Database for consumption in Italy; Eurostat (based on EU Statistics on Income and Living Conditions (EU-SILC)) for all other data.Sources for panel b: 2020 ECB Household Finance and Consumption Survey (HFCS) for euro area countries; UK Office for National Statistics for the United Kingdom; World Inequality Database (net personal wealth) for the United States.
- Globalisation and skill-biased technological change have adversely affected the wages and employment of lowerskilled labour and benefited higher-skilled labour and owners of capital.
- [9] At the same time, declines in the progressivity of the tax system have contributed to increases in post-tax inequality.
- [10] A recent study summarised potential drivers of inequality at the various economic stages i.e.
- policies in the pre-production stage focusing on people entering the workforce (e.g.
- [11] Its findings suggest that the rise in income and wealth inequality has been driven mainly by structural policies (e.g.
- [14] Governments have instruments at their disposal that are better suited to addressing excessive levels of inequality, such as taxation (e.g.
- progressive taxes on income, wealth and inheritance), transfers, market regulation, and access to education and health services.
Inequality and the business cycle
- The cyclicality of income inequality differs across countries, while wealth inequality tends to be procyclical.
- While lower-income households tend to be more affected by recessions as a result of the greater sensitivity of their labour income (see below), higher-income households tend to be more exposed to the business cycle as a result of capital income (e.g.
- Since the distribution of labour and capital income differs across countries, the cyclicality of income inequality can also differ.
- The procyclicality of profits and equity prices means that equities are not conducive to smooth consumption over the business cycle.
- [16] Consequently, the cyclical properties of certain asset prices can become a longer-term determinant of wealth inequality.
- The cyclical sensitivity of earnings differs across households, which gives macroeconomic stabilisation policies a role to play in averting longer-term increases in inequality.
Chart 4
“Worker betas” across the income distribution in the euro area (income elasticity of individual workers in relation to GDP growth)
Box 1 COVID-19 and income inequality in the euro area
- This box presents evidence for the euro area on the basis of household-level data on labour income, consumption and saving.
- The adverse implications for labour income have been particularly pronounced for younger workers, women and households with lower levels of income.
- [19] Those measures have particularly affected sectors where physical distancing rules are difficult to follow, such as hospitality, travel, arts and entertainment.
- These results are consistent with evidence from other countries indicating that the pandemic is likely to aggravate household inequality.
- [20] As a result, the pandemic is likely to amplify existing income inequalities, in line with the findings for previous pandemics.
Chart A
Impact of COVID-19 broken down by age, gender and income quintile (percentages) Source for panel a: EU-SILC (2017 data for Ireland and Slovakia; 2018 data for all other countries).Sources for panel b: EU-SILC (2017 data for Ireland and Slovakia; 2018 data for all other countries) and Eurostat Household Budget Survey.
In contrast to labour income, the decline in household consumption has been particularly pronounced in the upper parts of the income distribution, with high-income households strongly reducing their spending on non-essentials, which make up almost 45% of the total expenditure of households in the top quintile.[22] Those households have made a disproportionate contribution to the substantial increase seen in the aggregate saving rate, both because goods and services affected by lockdown measures make up a larger percentage of their total consumption, and because their income has been less affected.
3 Monetary policy and household inequality
How does monetary policy affect income and wealth inequality?
- The economic literature has identified three main channels through which a change in the monetary policy stance can have distributional consequences for household wealth and income.
- The first is the savings remuneration (and cost of debt) channel, which stems from differences in the size and composition of household balance sheets.
- The second is the asset price channel, which stems from the heterogeneity of household portfolios and the diverse capital gains (or losses) that are produced when the monetary policy stance changes.
Monetary policy and inequality: empirical evidence from the euro area
- This mainly depends on the extent to which households interest-bearing assets have short maturities and their mortgages have adjustable rates.
- In contrast, the net interest income of middle-class households has increased as interest rates have declined, mainly because they have relatively high levels of mortgage debt.
- Finally, richer households have recorded a net loss of interest income, since they tend, on average, to be less indebted.
Chart 5
Changes in net interest income across the income and wealth distribution (EUR per household; change in annual net interest income, 2007-19)
- The first involves unemployed people finding jobs and generally experiencing a substantial increase in income as a result (the earnings heterogeneity channel).
- [25] The probability of this outcome depends on peoples demographic characteristics (age, level of education, marital status, number of children, etc.).
- The easing of monetary policy through the ECBs asset purchase programme (APP) has substantially reduced the unemployment rate in the lower part of the income distribution.
- The aggregate decline in the unemployment rate (which totals around 0.7percentage points) affects individuals very differently, mainly benefiting households with incomes in the lowest quintile.
- Their unemployment rate falls by more than 2 percentage points, while the unemployment rates of all other income quintiles fall by less than 0.5 percentage points.
Chart 6
Impact of monetary easing via the APP (percentage points) (percentages)
- Panel b of Chart 6 breaks the overall increase in mean income down into (i) the part that is due to the decline in unemployment (the earnings heterogeneity channel) and (ii) the part that is due to the increase in wages for all workers (the income composition channel).
- The earnings heterogeneity channel has a particularly strong impact in the bottom quintile, where wage growth plays a very small role.
- However, it also accounts for the bulk of the total impact on income in three of the other four quintiles (with the top quintile being the exception).
- Overall, the labour market impact of the APP is estimated to result in some reduction in income inequality.
- The mean income of the lowest quintile rises by more than 3%, while those of other quintiles increase by around 0.5%.
- Housing is fairly evenly distributed across euro area households, with a large percentage (around 60%) owning their main residence.
Box 2 Monetary policy and regional inequality
- [36] That increase in regional inequality has attracted attention, but the contribution made by monetary policy has not yet been considered.
- And of the various policy domains, monetary policy is an interesting candidate, given its important role in steering macroeconomic outcomes over the last decade.
- Thus, the identification strategy posits that, controlling for macro conditions, monetary policy does not respond to economic activity at the regional level.
- The results point to pronounced heterogeneity in the regional patterns of monetary policy transmission.
- For instance, panel a of Chart A compares the dynamic response of regional output to a monetary policy shock at the 5th and 95th percentiles of the distribution.
- As a consequence, the easing of monetary policy mitigates regional inequality and policy tightening aggravates it.
Chart A
- Impact of monetary policy at regional level (percentages) Source: Hauptmeier et al., op.
- cit.Notes on panel a: This panel shows the impact that a 100 basis point interest rate cut has on regional GDP (in percentages).
- Lines denote point estimates, and shaded areas denote 90% confidence intervals.
- The red line depicts estimates for the 95thpercentile of the conditional distribution of GDP at regional level; the yellow line depicts the 5th percentile; the dashed line depicts the mean.
These findings illustrate the role that is played by the distributional effects of monetary policy (including along geographical lines). Moreover, while discussions regarding the unequal geographical impact of euro area monetary policy typically focus on cross-country differences, this analysis shows that the issue of geographical heterogeneity runs deeper than that: interregional heterogeneity becomes more accentuated at more granular geographical levels, and that heterogeneity, in turn, profoundly alters the implications of a given monetary policy stance in different parts of the economy.
4 Heterogeneity and the transmission of monetary policy to household spending
Whereas the previous section focused on the impact that monetary policy has on income and wealth inequality, this section looks at the ways in which the distribution of income and wealth shapes the transmission of monetary policy to households. Specifically, it estimates the manner in which the transmission of monetary policy to consumption varies across individual households on the basis of the structure of their income and wealth, their marginal propensity to consume (MPC) and the ways in which their income responds to aggregate shocks.
Direct and indirect transmission channels for monetary policy
- The effects that monetary policy has on individual households can be grouped together in two broad categories: direct and indirect.
- Direct effects are the immediate, partial-equilibrium consequences of the change in interest rates.
- These include the impact that the different interest rate paths have on households net financial income (net interest rate exposure).
- A second direct effect of monetary policy involves changes to households saving incentives (intertemporal substitution).
- Indirect effects operate through the general equilibrium responses of prices and wages (and thus labour income and employment).
- When policy rates are reduced, the resulting direct increase in household expenditure (and investment by firms) leads to an increase in output and exerts upward pressure on employment and wages.
Empirical estimates for the euro area
- [40] Authors have found it useful to classify households on the basis of the amount of liquid assets that they hold.
- Households with few liquid assets tend to have large MPCs, and they are often described as hand-to-mouth, because they tend to consume all of their income.
- [41] They can be either poor (if they do not own any assets) or wealthy (if they have positive illiquid wealth (e.g.
- On the basis of that classification, 10% of euro area households are poor hand-to-mouth, 12% are wealthy hand-to-mouth and 78% are non-hand-to-mouth.
- As Chart 7 shows, spending by hand-to-mouth households increases more strongly than spending by non-hand-to-mouth households in response to an easing of monetary policy.
- A 100 basis point cut in real interest rates increases consumption by poor hand-to-mouth households by almost 1% and increases consumption by wealthy hand-to-mouth households by 1.6%, while consumption by other households increases by just 0.5%.
Chart 7
Estimated impact on consumption of a 100 basis point cut in real interest rates in the euro area (percentages)
- The effect that this channel has on consumption is amplified because those households have larger MPCs than other households.
- [44] Accounting for differences across households is important when assessing the impact that monetary policy has on aggregate consumption.
- In general, monetary policy has only a temporary impact on the economy, with its effects tending to dissipate in the long run.
- by means of progressive taxation), will tend, in the long run, to be more important drivers of inequality than monetary policy.
Box 3 Capital gains, welfare and consumption
- First, to what extent have those capital gains contributed to wealth inequality?
- And second, to what extent have they generated wealth effects on consumption, thereby stimulating aggregate activity?
- It is not true, for example, that equity holders always benefit via capital gains when interest rates fall.
- Importantly, liabilities also include consumption plans, and assets also include human capital.
- Thus, capital gains resulting from lower interest rates have no effect on households whose dividend streams are equal to their planned consumption.
- Instead, lower interest rates benefit households who hold long-term assets for the purpose of financing short-term consumption (e.g.
- older households who hold equity shares or long-term bonds), through the capital gains that they generate.
- [47] Again, however, households will alter their consumption in different ways, depending on their investment plans.
Chart A
The relationship between wealth effects and age (percentages)
5 Conclusion
- In many advanced economies, inequality has been on the rise for several decades, mainly as a result of factors other than monetary policy.
- In the euro area, for example, income and wealth inequality are both generally lower than in the United States.
- globalisation), policies other than monetary policy have been key in explaining those cross-country differences.
- After all, most advanced economies have, since the 1980s, tended to adopt fairly similar monetary policy frameworks, with inflation remaining low and stable.
- Indeed, the easing of monetary policy would seem, overall, to have dampened economic inequality in recent years.
