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Monetary Policy and Inequality in the U.S. Olivier Coibion College of William and Mary Yuriy Gorodnichenko UC Berkeley John Sivia Wells Fargo

Global Interdependence Center March 2012


Top 10% Income Share

50% 45% 40% 35% 30%

Including capital gains 1917 1922 1927 1932 1937 1942 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007

25%

Standard Explanations for Rising U.S. Income Inequality: 1. Skill-biased technical change 2. Trade globalization 3. Institutional changes, e.g. declining unionization, deregulation/growth of financial sector


Channels from Monetary Policy to Consumption/Income Inequality • Heterogeneous wage/employment effects across population: a) different complementarities with capital for skilled/unskilled b) different industry sensitivity to interest rate changes (e.g. durables vs. nondurables, cost channels and liquidity constraints) c) insiders vs. outsiders in the firms (e.g. seniority)


Channels from Monetary Policy to Consumption/Income Inequality • Heterogeneous wage/employment effects across population: a) different complementarities with capital for skilled/unskilled b) different industry sensitivity to interest rate changes (e.g. durables vs. nondurables, cost channels and liquidity constraints) c) insiders vs. outsiders in the firms (e.g. seniority) • Income/consumption composition effects: a) importance of labor earnings vs. financial income vs. business income vs. transfers b) importance of durable goods purchases and other interest-sensitive expenditures


Channels from Monetary Policy to Consumption/Income Inequality • Heterogeneous wage/employment effects across population: a) different complementarities with capital for skilled/unskilled b) different industry sensitivity to interest rate changes (e.g. durables vs. nondurables, cost channels and liquidity constraints) c) insiders vs. outsiders in the firms (e.g. seniority) • Income/consumption composition effects: a) importance of labor earnings vs. financial income vs. business income vs. transfers b) importance of durable goods purchases and other interest-sensitive expenditures • Wealth effects on consumption and labor supply decisions: a) real interest rate increase is a transfer from borrowers to savers b) different portfolio allocations will also affect wealth outcomes


Channels from Monetary Policy to Consumption/Income Inequality • Heterogeneous wage/employment effects across population: a) different complementarities with capital for skilled/unskilled b) different industry sensitivity to interest rate changes (e.g. durables vs. nondurables, cost channels and liquidity constraints) c) insiders vs. outsiders in the firms (e.g. seniority) • Income/consumption composition effects: a) importance of labor earnings vs. financial income vs. business income vs. transfers b) importance of durable goods purchases and other interest-sensitive expenditures • Wealth effects on consumption and labor supply decisions: a) real interest rate increase is a transfer from borrowers to savers b) different portfolio allocations will also affect wealth outcomes

We want to assess the empirical importance of these channels. Do monetary policy changes meaningfully affect income/consumption inequality?


How we do this:

• Step 1: Identify “Unusual” Changes in Monetary Policy as suggested by Christina and David Romer Fed Funds changes that deviate from “usual” behavior 1.4 1.2 1 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 1980

1985

1990

1995

2000

2005


How we do this: • Step 2: Measure income and consumption inequality across households in the United States over time using the Survey of Consumer Expenditures Household Labor Earnings


How we do this: • Step 2: Measure income and consumption inequality across households in the United States over time using the Survey of Consumer Expenditures Household Total Income = Household Labor Earnings +

Household Business Income

+

Household Financial Income (bonds, dividends)

+

“Other” Household Income (Soc. Sec., UE benefits, alimony, pensions, welfare, etc…)


How we do this: • Step 2: Measure income and consumption inequality across households in the United States over time using the Survey of Consumer Expenditures Household Total Income = Household Labor Earnings +

Household Business Income

+

Household Financial Income (bonds, dividends)

+

“Other” Household Income (Soc. Sec., UE benefits, alimony, pensions, welfare, etc…)

Household Consumption = Purchases of Non-Durables and Services + Purchases of Durables (furniture, TV’s, etc…)


How we do this: • Step 2: Measure income and consumption inequality across households in the United States over time using the Survey of Consumer Expenditures Household Total Income = Household Labor Earnings +

Household Business Income

+

Household Financial Income (bonds, dividends)

+

“Other” Household Income (Soc. Sec., UE benefits, alimony, pensions, welfare, etc…)

Household Consumption = Purchases of Non-Durables and Services + Purchases of Durables (furniture, TV’s, etc…) Household Expenditures = Household Consumption + Mortgage Payments (if any) + Auto Purchases (if any) + Other Expenditures (education, medical, house expenses, …)


How we do this:

• Step 2: Measure income and consumption inequality across households in the United States over time using the Survey of Consumer Expenditures 0.5 0.48 0.46

Gini Coefficient

0.44 0.42 0.4 0.38 0.36 0.34 0.32 0.3

1985 Recessions

1990 Income

1995 Earnings

2000 Expenditures

2005 Consumption

This distribution of households does NOT include the 1%.


How we do this:

• Step 3: Determine what happens to income and consumption along different parts of the distribution after monetary policy shocks.


The Effects of Monetary Policy Shocks by Percentile Income Inequality

Earnings Inequality

0.06

0.1

0.04 0.05

0.02 0

0 -0.02

P10 P25 P50 P75 P90

-0.04 -0.06 -0.08

2

4

6

8

10

12

14

16

18

-0.05

20

-0.1

2

4

6

Expenditure Inequality

8

10

12

14

16

18

20

16

18

20

Consumption Inequality

0.15

0.08 0.06

0.1

0.04 0.02

0.05

0 0

-0.02 -0.04

-0.05

-0.06 -0.1

2

4

6

8

10

12

14

16

18

20

-0.08

2

4

6

8

10

12

14

Monetary policy affects labor earnings differently across the distribution.


The Effects of Monetary Policy Shocks by Percentile Income Inequality

Earnings Inequality

0.06

0.1

0.04 0.05

0.02 0

0 -0.02

P10 P25 P50 P75 P90

-0.04 -0.06 -0.08

2

4

6

8

10

12

14

16

18

-0.05

20

-0.1

2

4

6

Expenditure Inequality

8

10

12

14

16

18

20

16

18

20

Consumption Inequality

0.15

0.08 0.06

0.1

0.04 0.02

0.05

0 0

-0.02 -0.04

-0.05

-0.06 -0.1

2

4

6

8

10

12

14

16

18

20

-0.08

2

4

6

8

10

12

14

Effects on consumption across the distribution are very similar.


The Effects of Monetary Policy Shocks by Percentile Income Inequality

Earnings Inequality

0.06

0.1

0.04 0.05

0.02 0

0 -0.02

P10 P25 P50 P75 P90

-0.04 -0.06 -0.08

2

4

6

8

10

12

14

16

18

-0.05

20

-0.1

2

4

6

Expenditure Inequality

8

10

12

14

16

18

20

16

18

20

Consumption Inequality

0.15

0.08 0.06

0.1

0.04 0.02

0.05

0 0

-0.02 -0.04

-0.05

-0.06 -0.1

2

4

6

8

10

12

14

16

18

20

-0.08

2

4

6

8

10

12

14

Effects on total income are smaller for 10th, 25th percentiles, similar for 50th and above.


Why does income at low percentiles decline by less than earnings? Quintiles by consumption of nondurables and services

Share of income source Labor Earnings

Business

Financial

Other

(1)

(2)

(3)

(4)

Panel A: 1980s 1 2 3 4 5 Panel B: 1990s 1 2 3 4 5 Panel C: 2000s 1 2 3 4 5

Ratio of mean consumption of nondurables and services to mean consumption of nondurables and services in the 3rd quintile (5)


Why does income at low percentiles decline by less than earnings? Quintiles by consumption of nondurables and services

1 2 3 4 5

1 2 3 4 5

1 2 3 4 5

Labor Earnings

Business

Financial

Other

(1)

(2)

(3)

(4)

Ratio of mean consumption of nondurables and services to mean consumption of nondurables and services in the 3rd quintile (5)

0.022 0.040 0.057 0.059 0.088

Panel A: 1980s 0.112 0.112 0.096 0.081 0.078

0.515 0.260 0.153 0.098 0.067

0.42 0.73 1.00 1.34 2.18

0.020 0.040 0.050 0.056 0.082

Panel B: 1990s 0.106 0.097 0.086 0.071 0.076

0.494 0.267 0.160 0.103 0.069

0.43 0.73 1.00 1.35 2.27

0.019 0.029 0.037 0.042 0.051

Panel C: 2000s 0.086 0.085 0.072 0.065 0.071

0.460 0.234 0.151 0.092 0.065

0.43 0.73 1.00 1.36 2.32

Share of income source

0.352 0.588 0.694 0.762 0.767

0.380 0.597 0.704 0.770 0.773

0.435 0.653 0.740 0.801 0.812

Government transfers dampen the effects of shocks on low-income households.


The Effects of Monetary Policy Shocks by Percentile Income Inequality

Earnings Inequality

0.06

0.1

0.04 0.05

0.02 0

0 -0.02

P10 P25 P50 P75 P90

-0.04 -0.06 -0.08

2

4

6

8

10

12

14

16

18

-0.05

20

-0.1

2

4

6

Expenditure Inequality

8

10

12

14

16

18

20

16

18

20

Consumption Inequality

0.15

0.08 0.06

0.1

0.04 0.02

0.05

0 0

-0.02 -0.04

-0.05

-0.06 -0.1

2

4

6

8

10

12

14

16

18

20

-0.08

2

4

6

8

10

12

14

Effects on expenditures are similar to consumption, but display disproportionately large increases in expenditures for those at the high-end of the distribution.


Why do expenditures at high percentiles rise so much? Shares in consumption Quintiles by consumption of Nondurables nondurables and services (1)

Selected shares in total spending

Durables

Services

Interest sensitive expenditures

(2)

(3)

(4) Panel B: 1990s

1 2 3 4 5

Mortgage payments

Purchases of new vehicles

(5)

(6)

Ratio of total spending to consumption of nondurables and services (7)


Why do expenditures at high percentiles rise so much? Shares in consumption Quintiles by consumption of Nondurables nondurables and services (1)

1 2 3 4 5

0.655 0.637 0.631 0.613 0.567

Selected shares in total spending

Durables

Services

Interest sensitive expenditures

(2)

(3)

(4)

0.059 0.084 0.096 0.109 0.116

0.285 0.279 0.273 0.278 0.317

Panel B: 1990s 0.113 0.175 0.215 0.246 0.267

Mortgage payments

Purchases of new vehicles

(5)

(6)

Ratio of total spending to consumption of nondurables and services (7)

0.021 0.050 0.074 0.094 0.100

0.015 0.034 0.040 0.046 0.051

2.13 2.08 2.03 2.02 1.91

There is no dramatic difference in the allocation of consumption or expenditures for those at the upper end of the distribution relative to previous quintiles.


Why do expenditures at high percentiles rise so much? Redistributive wealth effects: do we see differential response in expenditures of savers relative to borrowers?


Why do expenditures at high percentiles rise so much? Total income

Earnings

0.2

0.4

0.1

0.2

0

0

-0.1

-0.2

-0.2

-0.4

-0.3

5

10

-0.6

15

5

Total expenditures 0.1

0.1

0.05

0

0

-0.1

-0.05

5

10

-0.1

15 CI

15

Consumption

0.2

-0.2

10

Low net-worth

High net-worth

5

10 Everybody else

15

There is no important difference in long-run total income across groups but‌


Why do expenditures at high percentiles rise so much? Total income

Earnings

0.2

0.4

0.1

0.2

0

0

-0.1

-0.2

-0.2

-0.4

-0.3

5

10

-0.6

15

5

Total expenditures 0.1

0.1

0.05

0

0

-0.1

-0.05

5

10

-0.1

15 CI

15

Consumption

0.2

-0.2

10

Low net-worth

High net-worth

5

10 Everybody else

15

High net-worth households have large increases in consumption and expenditures, consistent with positive wealth effect of redistribution.


The contribution of “unusual� monetary policy to U.S. inequality


The contribution of “unusual” monetary policy to U.S. inequality Income Inequality

Earnings Inequality

0.1 0.1 0.08 0.06

0.05

0.04 0 0.02 -0.05

0 -0.02 1985

1990

1995

2000

2005

1985

Recessions

contribution of MP shocks

Expenditure Inequality

1990

1995

2000

2005

actual Consumption Inequality

0.06

0.03

0.04

0.02 0.01

0.02

0 0 -0.01 -0.02

-0.02

-0.04

-0.03 1985

1990

1995

2000

2005

1985

1990

1995

2000

2005

“Unusual” monetary policy actions helped reduce income and earnings inequality from the mid-1990s to late 2000s.


The contribution of “unusual� monetary policy to U.S. inequality Income Inequality

Earnings Inequality

0.1 0.1 0.08 0.06

0.05

0.04 0 0.02 -0.05

0 -0.02 1985

1990

1995

2000

2005

1985

Recessions

contribution of MP shocks

Expenditure Inequality

1990

1995

2000

2005

actual Consumption Inequality

0.06

0.03

0.04

0.02 0.01

0.02

0 0 -0.01 -0.02

-0.02

-0.04

-0.03 1985

1990

1995

2000

2005

1985

1990

1995

2000

2005

but contributed to cyclical fluctuations in consumption inequality.


What about the Volcker disinflation?


What about the Volcker disinflation? Income Inequality

Earnings Inequality

0.1 0.1

0.08 0.06

0.05

0.04 0 0.02 -0.05

0 -0.02 1985

1990

1995

2000

2005

1985

Expenditure Inequality

1990

1995

2000

2005

Consumption Inequality 0.04

0.06 0.04

0.02 0.02 0

0 -0.02

-0.02 -0.04 1985

1990

1995

2000

2005

1985

1990

1995

2000

2005

Volcker disinflation did not contribute much to income or earnings inequality‌


What about the Volcker disinflation? Income Inequality

Earnings Inequality

0.1 0.1

0.08 0.06

0.05

0.04 0 0.02 -0.05

0 -0.02 1985

1990

1995

2000

2005

1985

Expenditure Inequality

1990

1995

2000

2005

Consumption Inequality 0.04

0.06 0.04

0.02 0.02 0

0 -0.02

-0.02 -0.04 1985

1990

1995

2000

2005

1985

1990

1995

but likely contributed to the rising expenditure and consumption inequality of the 1980s.

2000

2005


What about in recent years?


What about in recent years? 7

6

5

4

3

2 FFR Target Range

1

0

-1

Actual FFR

Predicted Values

-2 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: San Francisco Fed

Since 2009, the Fed has been unable to lower interest rates the way it normally would have: monetary policy has not been able to supply the typical expansionary impetus for this stage of the business cycle.


What about in recent years? 7

6

5

4

3

2 FFR Target Range

1

0

-1

Actual FFR

Predicted Values

-2 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: San Francisco Fed

Since 2009, the Fed has been unable to lower interest rates the way it normally would have: monetary policy has not been able to supply the typical expansionary impetus for this stage of the business cycle. So income and consumption inequality are most likely higher than they would have been had the Fed been able to respond in an unconstrained fashion.


Monetary Policy and Inequality in the U.S.