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Post Are Low Interest Rates the Result of Inequality? A Fed Paper
Created by John Eipper on 09/03/21 10:45 AM

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Are Low Interest Rates the Result of Inequality? A Fed Paper (Jordi Molins, -Spain, 09/03/21 10:45 am)

A recent paper presented at the Jackson Hole Fed conference argues that the main reason for the decline in interest rates is the increase in inequality:

https://www.kansascityfed.org/documents/8337/JH_paper_Sufi_3.pdf

Traditionally, it was thought that a decline in interest rates was due to demography: Baby Boomers were busy investing for their retirement, boosting asset prices, leading yields down.

Such a hypothesis argues that, soon, Baby Boomers will retire, and they will start spending their savings, leading to higher wages for young people, inducing high inflation rates.

However, the Japanese experience seems to falsify such a hypothesis: wage growth has been stagnant, even though the Japanese elderly are consuming their savings.

The explanation for the Japanese conundrum is that aging reduces growth, which reduces investment, which reduces the need for new employment. In a sense, aging is a trap.

But the paper above goes even further: high US asset prices are directly linked to inequality. The reason is that wealthy people are gathering an inordinate amount of wealth, in comparison to historical norms. And wealthy people consume a small proportion of their wealth, investing most of it instead.

As a consequence, there seems to be a Molotov-Ribbentrop 2.0 kind of deal between liberals and conservatives in the US: while the liberals accept a high inequality rate in order to be able to accomplish their main goal (low interest rates, which lead to easiness in issuing government debt, which can be used to be spent freely), conservatives accept high government spending in order to be able to accomplish their main goal (low interest rates, leading to high asset prices, leading to the wealthy becoming richer, inducing higher inequality).

It seems this equilibrium is a quite stable one. Only unexpected circumstances (Black Swans) could derail it.

JE comments:  This is a perfect correlation-causality conundrum.  At present we have high inequality and low interest rates, but I never fathomed that one could cause the other.  Intuitively you'd think the opposite:  low interest rates stimulate large purchases by the non-wealthy, and set in motion the virtuous cycle of consumption, investment, production, high employment and the like. But on the other hand, who gets access to the rock-bottom interest rates?  Big institutions and the rich:  inequality.

Come to think of it, inequality in the US probably was at its lowest during the Malaise Era of the 1970s.  This was also the time of historically high interest rates.

Lots of food for thought in this corner of the Dismal Science.  No one running for office would ever advocate raising interest rates to make us more equal, but would it actually work?

"Molotov-Ribbentrop 2.0":  Jordi, that's a brilliant turn of phrase.


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