Central bankers should own up to the trade-offs in ultra-loose monetary policy

Central bankers are a conservative tribe but they have torn up the rulebook since the financial crisis a decade ago. They have pushed interest rates down to record lows, even into negative territory. And through quantitative easing they have bought bonds with newly created money on an epic scale. This has vexed savers who rely on interest from deposits rather than investments. There is widespread concern about the fairness of policies that have stoked asset prices.

These criticisms get short shrift in a recent discussion paper from the European Central Bank. “On the whole we find that monetary policy in recent years benefited most households and did not contribute to an increase in wealth, income or consumption inequality,” said the six economists (five from the ECB and one at Princeton University). This chimed with similar conclusions in research from the Bank of England earlier this year. How convincing are these findings, especially given that they are being published by the very institutions under scrutiny?

In big-picture terms, central bankers have a strong case to make (though they can be blamed for allowing the financial crisis to blow up in the first place). Their battery of unorthodox policies blunted the recession that followed the crisis and stimulated a recovery. That in turn boosted labour income and curbed unemployment.

These overall beneficial effects have outweighed the costs for example to savers in lower interest, according to the ECB research. Indeed a disproportionately big drop in unemployment among poorer households is the main reason why it finds that quantitative easing (which the ECB belatedly began in 2015) has modestly reduced income inequality in the four biggest eurozone economies.

A similar story can be told for Britain. Indeed a notable feature of the recession was that unemployment rose by less than had been feared—and then fell by more than expected. The Bank of England reckons that the unemployment rate would have been four percentage points higher but for its policy loosening.

If central banks can occupy the high ground in terms of the overall impact of their policies, the claim that they have had no adverse effect on wealth distribution is more controversial. Their flagship policy of QE works mainly through a “portfolio rebalancing” effect whereby purchases of government debt ripple through asset markets, pushing up their prices, and thus making their owners richer.

Economists at the BoE spelt out the way that portfolio rebalancing worked in 2010, a year after it had started to buy government bonds (gilts). They wrote: “The increase in demand for gilts resulting from the Bank’s purchases will raise their prices and lower their yields. And the impact of the purchases should be felt across a range of assets, as sellers of gilts to the Bank use their new money balances to bid up the prices of other assets.”

Those other assets include equities, which had nosedived during the financial crisis but then soared in the QE era. Since equities are held primarily by richer households, this is likely to exacerbate wealth inequality. Indeed this effect was demonstrated in research from the Bank for International Settlements (the central banks’ bank) in 2016 examining six advanced economies including Britain. Set against this, equities are also held by pension funds with much wider beneficiaries than rich households.

But ultra-loose monetary policy has also revived housing markets with prices recovering sharply since the bust resulting from the crisis. Since property wealth is spread more broadly across the population that can counter the adverse effect of equities on wealth inequality. Broadly speaking, this is what both the ECB and the BOE teams find.

This verdict is unlikely to satisfy the central banks’ critics not least since in absolute terms the rich have indeed done much better. The BoE research showed that the effects of monetary policy since the financial crisis on increasing net wealth have been somewhat more favourable for poorer than richer households in percentage terms. But because wealth is so unevenly distributed, the cash increases among the rich were far greater than among the poor. The researchers estimated an average increase of around £3,000 between 2006-08 and 2012-14 for the poorest tenth of British households whereas there was a gain of £350,000 for the richest decile.

These findings hinge on identifying the contribution of central bank policy. This involves a whole range of estimates which may be plausible but are hardly reliable. For example, the BoE was taken aback by the scale of drops in unemployment after issuing in August 2013 forward guidance linked to the jobless rate. That calls into question the precision of its estimate for the impact of its policies on unemployment. A further doubt is that its conclusion about the overall impact of its policies on wealth inequality—a small reduction—jars with official surveys showing that the overall wealth distribution has become a bit more unequal since 2006-08, with bigger increases in inequality for net property wealth and particularly net financial wealth (excluding pensions).

Most important, ultra-loose monetary policies create losers as well as winners in the property market. Higher house prices may have spread wealth more widely among existing older homeowners. But they are locking out a whole younger generation that cannot afford to pay such elevated prices. And though higher equity prices might boost private pension pots, falling annuity rates (which are linked to gilt yields pushed down through quantitative easing) may obviate any gains in the actual pension that those pots can buy.

Central bankers have a good story to tell about their bold monetary experiment. But they should avoid a tall story. Low interest rates and quantitative easing have a welcome effect on economic activity and employment but a potentially undesirable impact on financial stability and wealth inequality. Central banks should acknowledge these trade-offs rather than seeking to deny them.