Almost 10 years after the Great Recession ended, the growing threat of a new economic slowdown raises a troubling question: When the next recession strikes, what can the world’s central banks do? With interest rates low and their balance sheets still loaded with assets bought to fight the 2008 crisis, do they have the tools to respond?
The Great Recession was supposed to be a great reset, an end to an economic boom that had made the rich richer and left almost everyone else behind. The conventional wisdom at the time was that Wall Street bankers and those in the upper-income brackets would be hurt the most – more or less a repeat of the Great Depression, which wiped out much of the vast inequality of the 1920s.
But that’s not what happened – if anything, the exact opposite occurred. Insurance firm Allianz in a study last year found that from 2010-2017 the wealth gap in the U.S. between rich and poor had grown the fourth fastest out of the more than 50 countries they had looked at, behind only Bulgaria, Slovenia and New Zealand. As if more evidence were needed, the U.S. Gini co-efficient, a popular though flawed gauge of inequality, now stands at 0.48, up from 0.46 before the financial crisis. [A reading of 0 means total equality, while 1 indicates one person holds all the wealth.]
A new paper from economists Ernest Liu, Atif Mian and Amir Sufi suggests the reason the recession didn’t put a dent in inequality may very well be the Federal Reserve’s fault. Low interest rates, particularly when they get close to zero, tend to increase inequality, even as they revive the economy, the economists argue. That’s not a totally surprising conclusion. Low rates boost stock and other asset prices while depressing the returns of small savers. And 90% of stock-market wealth is owned by the top 10%.
[Fed] needs to find new tools to fight recession.
But Liu, Mian and Sufi argue that’s not the most important inequality-transmission mechanism of low interest rates. The real wealth transfer comes from the fact it’s the well-off, both individuals and companies, who have the easiest time borrowing in times of financial crisis. Another problem: As inequality grows, Fed actions become less effective. Rich borrowers don’t spend their interest savings, which tends to keep demand for consumable goods in check.
There are, to be sure, some reasons to be skeptical of this argument. Low interest rates during the Great Depression didn’t hold back the leveling of economic inequality. Furthermore, common ownership through index funds also has risen dramatically since the recession. Some believe that’s lowering competition, including for labor, and limiting wage gains. Central banking expert David Wessel, director of the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy, says there is no sign Fed officials see inequality as something that should limit their ability to lower interest rates in the face of a recession.
But is that what the Fed should do? At a minimum, holding off on interest rate cuts, while potentially causing more economic harm initially, could put more pressure on Washington lawmakers to act.
Economists who worry about inequality, including former Barack Obama administration official Jason Furman, think government spending will need to play a “large and sustained role” in combatting the next recession.
Beyond that, the Fed should do more to ensure credit is available for all, perhaps by giving a broader guarantee to community banks that tend to serve smaller businesses.
Whatever the Fed does, there is a strong case to be made that it needs to find new tools to fight recessions.
Another economic slowdown that leaves the well-off even more so, and the rest of us less so, will further undermine credibility in the Fed. That would certainly leave our entire economy and all of us, both rich and poor, worse off.
Stephen Gandel is a Bloomberg Opinion columnist.
