What’s the Big Deal About Inequality And What Role Does the U.S. Federal Reserve Play?

Why Does Inequality Matter?

The phenomenon of increasing wealth inequality has emerged as one of the major socio-political issues of our time. Arguments are raised regarding inequality’s root causes, the most effective policy prescriptions, and even whether it is a problem in the first place. The fact that the wealth gap is indeed widening, however, is one rare point of general agreement.

Take, for instance, the August 2017 New York Times piece by David Leonhardt titled "Our Broken Economy, in One Simple Chart." Leonhardt leads with a chart depicting the differences in income growth between 1980 and 2014, broken down by income percentiles. While those in the lower percentiles once saw higher income growth than those in the top, the situation flipped by 2014 in dramatic fashion.

Ray Dalio Enters the Fray

A LinkedIn blog post penned by famed hedge fund manager Ray Dalio surfaced in April of this year and kicked off another explosion of press coverage. Dalio, the billionaire founder of Bridgewater Associates, uses the blog post to defend his thesis that "capitalism is now not working for the majority of Americans."

Dalio acknowledges the productive power of capitalism, which he defines loosely as "the ability to make money, save it, and put it into capital." He believes capitalism has produced "self-reinforcing spirals" that have created widening income/wealth/opportunity gaps. He connects the phenomenon of widening inequality to the civil unrest and increasing ideological polarity that has led to the rise of populist political leaders worldwide.

Where the Fed Fits In

Dalio regards the Federal Reserve as a key player in his diagnosis of why capitalism is not working well for the majority of people. He states:

Central banks’ printing of money and buying of financial assets drove up the prices of financial assets.

Dalio explains that when the Federal Reserve buys financial assets to stimulate the economy, the sellers of those financial assets get richer, which makes the rich richer relative to those who don’t own them. He runs through a causal chain of events that he believes brought the U.S. economy to this point, noting central bank quantitative easing policy as having a significant impact on widening inequality.

Inequality and the Federal Reserve

Dalio’s points about the relationship between Federal Reserve policy and the price of financial assets have been recognized in various outlets. For instance, Esther George, President of the Federal Reserve Bank of Kansas City, commented on the risks of lower interest rates fueling asset bubbles.

Around this topic, others, such as Albert Gallo, identify a significant blame placed on central banks for the apparent relationship between their policies and widening inequality. Gallo mentions that sustained ultra-low interest rate policies give large firms an advantage through cheap funding and drive inequality.

On Inflation

In his blog, Dalio points out that real wages net inflation have not risen since the 1970s. Economic elements can stem from movements in both nominal value and the rate of inflation. Inflation has disparate effects, benefiting those with financial assets while disadvantaging those living paycheck-to-paycheck.

The Cantillon Effect

Inflation can be considered a "silent tax" that decreases the purchasing power of wealth held in cash. Money injections into the economy do not lead to higher prices all at once. According to Richard Cantillon, those who first receive newly created money enjoy purchasing goods and services at old prices.

When the Federal Reserve announces quantitative easing, it leads to increases in asset prices before a commensurate rise in wages, exacerbating wealth inequality.

Final Thoughts

Ray Dalio warns that a failure to understand why income inequality is becoming more extreme could result in significant societal conflicts. The discussion often overlooks how central bank policies benefit the wealthy while hurting lower-income communities.