In the post-2008 financial crisis economy, the Federal Reserve has received plenty of criticism for its quantitative easing approach, cited as one factor behind widening economic inequality in the U.S.
Karen Petrou, co-founder of Federal Financial Analytics, believes that the central bank not only contributed to the growing inequality among Americans, but also that it has the ability to reverse that inequality through targeted policies that stay within its mandates of maximum employment, price stability and long-term moderate interest rates.
Petrou’s new book, “Engine of Inequality: The Fed and the Future of Wealth in America,” explores those ideas. “Marketplace Morning Report” host David Brancaccio spoke to Petrou about her new book and what the Fed can realistically do right now to reverse the momentum of inequality. Below is an edited transcript of their conversation.
David Brancaccio: When I think of the shrinking middle class in America and widening inequality, I think of globalization, I think of the decline of unionization, I think about robots and artificial intelligence taking our jobs. You blame, in part, the Federal Reserve?
Karen Petrou: I do. I know that the Fed didn’t want to make us more unequal, but it did after 2010. And the reason is simple: Inequality is powered by an engine. The richer you are, the richer you get. The poorer you are, the poorer you get. And the fuel of that engine is money. And I think when we think about economic inequality, and we leave out the policies that drive the money, then therefore monetary policy and therefore the Fed, we’re missing a really critical part of the inequality problem. And one that’s a lot easier to fix than robots or globalization, unionization, some of the really big, important issues you also mentioned.
Brancaccio: Well, what happened after 2008, the last financial crisis? Interest rates came way down, superlow, stayed down. The other thing is, as part of that, the Fed bought up lots of generally safe assets like bonds and has this huge hoard of them. But low interest rates, I thought, that’s great, it keeps my credit card down, I can borrow for a car more easily.
Petrou: You can and I can, but a lot of Americans are already deep in debt because one of the things that’s happened in recent years, despite the Fed’s mandate for “price stability,” is that the cost of being middle, even upper-middle, class, and lower- or moderate-income, has gone way up. So all but the top 10% of Americans already have more debt than assets. We don’t need more debt, we need more employment and economic growth. And we critically need savings. That’s the engine of wealth accumulation. And right now, if you put your money into your savings account, you lose money because rates are negative in real terms, and they have been pretty much ever since 2008. Saving is a losing game. Investing is a winner’s game, but most Americans aren’t in the stock market. The top 1% of Americans have over half of our stock.
“You can’t lose investing. But you still lose a lot saving.”
Brancaccio: I mean, that’s something that the book really tries to emphasize. It’s that, you know, the stock market is one thing, but what happens in the stock market doesn’t necessarily trickle down. We don’t say “trickle down” anymore, by the way. It is a euphemism. We call it the “wealth effect.” You see that as not working?
Petrou: Oh, it’s working. The wealth effect is working great. If you’re in the top 1% or the top 10%, your wealth has skyrocketed. American wealth has grown faster than ever before since 2010. And our inequality, measured in terms of wealth, is not only wider than ever, but it grew faster than ever because the Fed not only powered up the markets with ultralow rates and its huge portfolio, it saved markets. Every time markets wobbled a little bit, the Fed stepped in. So you can’t lose investing. But you still lose a lot saving. That is, I think, both unequal and very risky, as we saw last March, when the markets blew up.
Brancaccio: And the wider culture often overstates the percentage of Americans who have a direct stake in the stock market, but we also forget that so many people have a very important stake in vehicles for savings, even though — like you can’t get a passbook savings account at a bank essentially because those don’t pay anything. But still, when interest rates are low, that directly hurts a large segment of the population?
Petrou: Absolutely. Many Americans, I’m sure many listeners, have 401(k)s. But those are a relatively small percentage of their assets compared to the importance of savings, and the 401(k) is a retirement plan. What about saving for a down payment? What about saving for a child’s education? The cost of health care and an unexpected expense? I mean, 40% of Americans can’t handle a tire blowout. And we saw that. Look at what happened to the economy last March. Even wealthier Americans have no savings and therefore no safety net. When the government shut down in 2018, over 60% of government workers couldn’t pay their mortgages or rent [because of] missing two paychecks, and they earn on average $85,000 a year. We need savings.
Brancaccio: I don’t mean to be deliberately obtuse, but let me just ask it this way. Let’s say I could sock away $1,000 in savings for an emergency, and interest rates were much higher, 4%? I mean, all right, over a year, what would I get, an extra $40? Does that really make a difference?
Petrou: No. In the book, I have several examples of showing what happens if you save and how if you put, say, $2,000 a year away for 20 years, even at very low inflation rates now, you’d have much less money after 20 years than you had put away — in nominal terms, $2,000 a year. Versus investing the same amount of money, you’d have 17%, 20%, 30% return on those assets. If you look at the equations in the book, you can really see what happens to most Americans and why a very few people are getting very rich.
Brancaccio: Let’s be really clear on that. In other words, I remember the example in the book, you put away $2,000 a year for something big in 20 years, maybe it’s an education or something. At these superlow interest rates, you end up — factoring in for inflation — with less money than you actually saved?
Petrou: That’s right. And if current Fed policy powered robust economic growth and people got more jobs with better pay, that might not be an unreasonable trade-off. But it hasn’t worked out that way. After 2010, we had the weakest economic recovery since the Second World War. And middle-class wages in 2019 were the same in real terms as they were in 2001. You really have to look not at the aggregate, the averages or the nominal numbers, what you see in your savings account, but what the real numbers are, what the real savings, real income, real growth are, and those have been slow, weak and inequitable.
Inequality and monetary policy
Brancaccio: You know, the new treasury secretary who used to be our central banker, the head of the Fed, Janet Yellen, doesn’t think this is true. She doesn’t think that Fed policy has hurt inequality, she doesn’t see this kind of collateral damage. I mean, you do link to a speech that Janet Yellen made in 2017, and she does acknowledge that things have been skewed toward the top of the income distribution. But then, continuing with a quote, “These unwelcome developments unfortunately reflect structural changes that lie substantially beyond the reach of monetary policy,” which is what the Fed controls. In other words, that’s her Fed-speak for, “It’s not the Fed’s fault that income inequality widened like this.”
Petrou: She does not want this to be the case. No one at the Fed wants it to be the case. But I hope my book shows that, unintentional though it was, it is in part the Fed’s fault because money is the fuel of economic inequality, the inequality engine. Every time the Fed steps into the market, the markets go up. The markets run by the Fed’s clock, and the people who profit from the markets are the wealthy. And one of the really hard things in the book we look at is that African Americans in this country are worse off now than they were before the civil rights era even began, and the sharpest decrease in African American income and wealth, especially wealth, happened after 2010. We really have to look at what happened then. No, globalization didn’t change, unionization — nothing changed as fast and as dramatically as monetary and regulatory policy after 2010. And economic inequality shows the impact of those changes. I don’t think that that’s arguable, the data are just too clear.
Brancaccio: So if you’re right, that policy is a real problem here in widening the gap between rich and poor in destructive ways. Perhaps you think policy could be a remedy?
Petrou: Oh, yes. My goal with this book, “Engine of Inequality,” was to try not only to show how it worked, but also how to put it into reverse. And one of the reasons financial policy is such an important cause of economic inequality is its real role as part of the solution. It’s an easier piece of the inequality problem to change because you don’t largely need Congress. You need the Fed to see its inadvertent impact and then to reverse it. That can happen, I think that should happen. I hope the book helps people see how to make it happen.
Brancaccio: What are some possible remedies? I mean, conservatives listening to this will say something they’ve said for a long time, which was, let’s get those interest rates back up. And let’s have the Fed restore its balance sheet, get rid of some of the hoard of assets that it has had on hand for over a decade now.
Petrou: I don’t think that’s just conservatives. Progressives, as well as populist conservatives and liberals, see that low interest rates, which are [the] proverbial remedy of theoretically liberal economic policy that’s supposed to help workers, hasn’t worked. I think this would be a liberal-conservative debate if liberals could show that ultralow interest rates generated sustainable income growth in real, inflation-adjusted, terms and improved the ability of lower-, moderate- and middle-income people to accumulate at least a little bit of wealth. And you can’t see that, there are no data to support that.
Interest rates and job creation
Brancaccio: Right. But if the push is to “normalize interest rates,” that means up, and immediately people are gonna think that’s gonna make it harder to create jobs.
Petrou: Well, with interest rates going up, I don’t think we’ll see the binge of market debt. The high-flying equity markets are the result, in part — if you’re wealthy, if you’re an institutional investor, a life insurance company, a pension fund, what are you going to do? You didn’t put your money in a savings account. You put your money in the market, and everyone is doing what’s called “yield chasing.” And is that building factories, creating jobs? No, it’s creating high-risk markets and very high corporate salaries. But it’s not generating growth. Normalized interest rates, I think, would lead to a normal balance of capital investment as well as savings. And that’s where we’re going to get jobs.
Brancaccio: But really, put this on the central bankers? I mean, they have this dual mandate, they talk about it all the time. There’s only two things they’re supposed to do well, which is make sure that inflation doesn’t go crazy — I mean worry about price stability — and also come up with policies that keep the labor market healthy, provide enough jobs. Two things.
Petrou: No, the Fed talks about two things, but if you read the law, it has a three-pronged mandate. That law says that the Fed is responsible for maximum employment, as the Fed says, but if you read the law, that is supposed to mean productivity and growth, not just one blip on a particular number. And [Chair] Jay Powell just said that he doesn’t even think the numbers the Fed has been citing since 2010 are right.
We need a better understanding of maximum employment, which is full employment. So that’s No. 1 in the Fed’s charter. It did not do that, and I hope it does. Price stability, again, if you read the law carefully, price stability means not just the Fed’s chosen measure. It means the ability of households to sustain their consumption, to support their lives without debt. And all but the top 10% have not been able to do that. American indebtedness, particularly for lower-income households, is way off the charts because of the cost. The cost of education is up 600% since 1980. Child care, health care, all those costs are sky-high.
And then the third part of the Fed’s mandate, which I spend a lot of time on in the book, the statute says, “moderate interest rates.” The Fed has ignored that because its view is that if it gets maximum employment and price stability, that implies moderate interest rates. But we know now after a decade of ultralow interest rates, that that’s not true. We have a three-pronged mandate, and I think the Fed needs to go back and read it with more care.
Brancaccio: You know, you point out this third prong for the central bankers that interest rates should be moderate. And we should really think about the word “moderate.” It doesn’t mean interest rates too high. But it also doesn’t mean interest rates so low they’re near zero, right?
Petrou: That’s right. Moderate, if you read the statute, means rates at which if I say I get a real return, rates at which banks are encouraged to lend, not just recycle the Fed’s big portfolio right back into the Fed. And it means rates that one can afford, whether it’s for a mortgage or a car loan. Not too low, not too high, except calibrated to support sustainable growth, not market speculation.
What the Fed thinks
Brancaccio: Karen, why don’t policymakers at the Fed see it the way that you do? I mean, they don’t wake up in the morning hellbent on widening economic inequality in America. Is it something about the data they get?
Petrou: Of course. You’re right. No, I know the members of the board, several of them very well. And I don’t think any one of them has anything but the best intentions. This is the result, I think, of bad data; data based on America the way it used to be.
I am the same age about as most of the members of the Fed. We went to school at a lot of the same places at the same time. And then there was a robust middle class. When I graduated from college in 1975, each of us earned a share of gross domestic product proportionate to our labors. America had rich people and poor people, but there was an equal return for how hard we worked, no matter how rich or poor we were. In 2019, the last year for those data, the top 1% got over 300% of its share, compared to what it would have received equitably in 1975. I think the Fed is looking at America as it was and trying the policies that used to work. But inequality is so pervasive and so wide now, in part because of the inadvertent effect of its policies, that those policies do a great deal of damage. We need to fix and follow the money and see what’s happened, not the old models.
Reduced bank lending at low interest rates
Brancaccio: Part of the idea here with these superlow interest rates is making borrowing easier so that a person with a small business could get a loan. Or a household that needed something crucial, like a way to pay for some health care, could get a loan for that. That hasn’t tended to happen?
Petrou: No, it hasn’t. And the reason is the combination of monetary and regulatory policy. My book is about the financial policy impact of the post-2010 rules and standards, because they work together. And banks have come under a lot of high, costly capital requirements since 2010. And they’ve made banks much, much safer, which was a good thing in March of 2010, but they have made it unprofitable. Banks lose money when they make loans at these low interest rates. Their cost of capital is actually higher than the interest rate they can get on making a loan. So banks actually have significantly reduced lending, particularly to consumers. And there are data in the book that demonstrate this very, very clearly. Now, sure, there’s a vibrant mortgage market, but that’s through the government. Banks act as originators, but they’re not lenders. The banks are not lending to grow the economy. They can’t because they’d lose money, and they’re still in business to make a profit.
Brancaccio: So what should we do? Deregulate? I mean, this is the kind of philosophy that led us to the last financial collapse.
Petrou: Oh no, my book is very strongly against deregulation. We had the 2008 crisis and we saw in 2010 the value of rules. The banks stood firm, it was the nonbanks that collapsed because they didn’t have the capital resources. That’s why we need a combined change in monetary policy to bring rates, interest rates, up to moderate rates, so that banks can make money making loans under tough rules.
We do need to change, though, some of the rules. There are inadvertent rules, particularly the cost of lending to lower-income people. We’ve got this thing built into the capital requirements that assumes that if somebody is poor, they’re a bad credit. That’s just not true. So that’s not deregulation, it’s revised, equity-focused regulation. And I think we can and should make those changes very fast. That won’t weaken the banking system — especially if we expand those rules to some of the key nonbanks — but it will increase credit and do so very quickly.
Brancaccio: OK, don’t lose that last point, too, right? A lot of this financial activity, a lot of this credit goes out through something that doesn’t identify itself as a bank. And so this burgeoning part of financial services has to be reckoned with if you’re changing regulation.
Petrou: I think that’s exactly right. We talk a lot about democratizing banking, and that led to the subprime crisis. Now, we talk a lot about financial inclusion. And my book is all about real sustainable financial inclusion. But when you get financial products from Facebook, I’m not so sure that that’s financial inclusion without some real fangs built into it. We need to be careful.