Are you mad at the Fed? You should be

In wide distribution remarksFederal Reserve Chairman Jerome Powell recently said the Fed’s COVID-19 response is “absolutely not” contributing to income inequality. But our data indicates that Powell’s claim is absolutely false. We are proposing an alternative policy that tackles the underlying source of the economic decline while seeking to ensure greater equity in the beneficiaries of the Fed’s actions. We are combining some common sense with a radical departure from Fed policy by stimulating the economy by supporting consumer credit, not business credit.

Since March, the Fed has printed and spent more than $ 2.9 trillion – about $ 22,000 per US household, buying a variety of securities in an attempt to keep interest rates low and stimulate the economy. The key assumption is that low interest rates will stimulate business spending, which will “trickle down” to labor markets, boosting employment. There are two problems with this approach in today’s environment:

  • Declining demand: The current slump in the economy is the direct result of a record decline in request due to the coronavirus pandemic. It was not caused by a lack of cheap credit. No matter how much money the government uses to subsidize business credit markets, why would businesses spend money on producing goods and services if customers (literally) stay at home? For example, Boeing has lifted $ 25 billion in the bond market at ultra-low rates. But a few weeks later he fired 10 percent of its workforce. Is it any surprise that the demand for airplanes is declining? Unfortunately, this type of behavior is more Standard As the exception: many companies use the proceeds of government-subsidized bond issues to create “war funds” of money rather than spending the money to stimulate labor markets.
  • Consumer Markets Frozen: The good news is that Fed actions have stabilized the mortgage market: Homeowners can still refinance at record rates. The caveat is that these low rates disproportionately benefit those who are able to refinance – a demographic that favors high-income homeowners. Indeed, major lenders have significantly tightened credit standards. For example, Wells fargo and chase away, two of the largest home equity lenders, suspended home equity loan offerings and dramatically increased minimum credit notes. As banks tighten consumer lending, this limits the extent to which the middle class can benefit from the Fed’s actions to keep rates low. Unemployed due to COVID-19 but with substantial home equity? Sorry. Refinancing is not an option.

So where does all the Fed’s money go if it doesn’t trickle down to labor markets and consumers? It is reinvested in financial assets, inflating their value. This explains why we are facing record unemployment ever seen since 1930s, but yet stock valuations are now higher than they have ever been in the past 15 years old.

Thus, the Fed’s policies fail to lower unemployment while inflating the value of financial assets. As such, they have a profound effect on the distribution of wealth. People in jobs that pay less than $ 40,000 a year, for example, face a double whammy.

First, they are more likely not to be able to work from home and, therefore, to face 40 percent unemployment in this environment. Second, these people rarely have investments, directly or indirectly through retirement savings. They are not participating in the Fed-induced market rally. So, contrary to what Powell claims, the Fed’s policies leave behind those most affected by the crisis – low-income workers – and disproportionately benefit those less affected by the crisis.

A different crisis calls for a different response. Rather than relying on the policies of the 2007-2008 playbook (that low interest rates in the business credit market spill over into labor markets), the Fed should write a new playbook and focus on consumer credit markets. Under the Term Asset Backed Securities Lending Facility (TALF), the Fed is allowed to buy (technically, accept as collateral) $ 100 billion in consumer loans, but only AAA-rated loans. We propose that the Fed expand its consumer loan programs to include lower-rated consumer loans (even unwanted loans) and unsecured loans. A risk-sharing agreement between the Fed and the lending banks for unsecured loans would significantly lower the rate on these loans and provide access to capital to the most disadvantaged people.

This program would help both homeowners and renters obtain cheap consumer finance. It would also allow the Fed to tackle the underlying source of the economic decline – a record drop in consumption. request – while guaranteeing the fairness of the beneficiaries of the Fed’s policies. The Fed argues that it buys junk bonds to subsidize credit to companies that have no other source of credit. So why not subsidize credit to consumers who have no other source of credit?

But what about the just announced Main Street loan program? He’s definitely targeting Main Street America, isn’t he? Read it small print. No “Main Street” business we know of has billions in sales or thousands of employees. Our idea: Create a loan program that supports consumer loans, loans that allow income-strapped consumers to continue paying their rents, continue to make their mortgage payments and continue to consume the goods and services offered. by the real main street.

The Fed can print and allocate money to whomever it wants (within the limits of its charter). We see little evidence to suggest that it acts in the interest of large segments of the public. And more worryingly, there is no mechanism that would discipline his behavior unless voters call on Congress for political oversight.

President Powell and the Fed need to be much more sensitive to consumers and factor income inequality into their policy decisions. Otherwise, the wave of populism hitting the United States will only grow, posing an existential threat not only to the independence of the Fed, but to the free market system as a whole.

Thomas Lys is Professor Emeritus at the Kellogg School of Management at Northwestern University. Daniel Taylor is an associate professor at the Wharton School at the University of Pennsylvania.

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