The European Central Bank (ECB) published a working paper assessing the impact of monetary policy on households inequality across the Euro Area. Specifically, the study deals with the impact of the recently adopted quantitative easing, on which recently came to public attention.
For example, commentators have pointed out that a prolonged reduction in policy interest rates can generate an income loss for savers holding interest-bearing assets, or that expansionary measures supporting financial asset prices are especially beneficial for the savers holding those assets. The paper reviews theoretical findings on the distributional effects of monetary policy on households’ income, wealth and consumption and it provides suggestive empirical evidence on their quantitative relevance with special emphasis on euro area countries.
The analysis first points out that monetary policy, always produces distributional effects. Empirical evidence available for various countries suggests that a reduction in policy interest rates compresses the distribution of income. There is a modest evidence that the Asset Purchase Program (APP) led to a reduction of income inequality in the four largest euro area countries. However, the overall effects of monetary policy on income inequality are modest, compared to its observed secular trend.
The direct effect operates through the modification of policy rates. A reduction in policy rates will decrease interest payments for households with net outstanding debt, but it will also reduce interest income for households holding net financial assets. The indirect effect operates through the general equilibrium responses of prices and wages, hence of labour income and employment. After a reduction in policy rates, the direct increase in households’ expenditure and firms’ investment will lead to an increase in output and it will exert upward pressure on employment and wages. The additional increases in aggregate expenditure induced by higher employment and wages are the essence of the indirect effect.
To assess the relative importance of direct and indirect effects, the paper analyses how the distributional implications of monetary policy on income and wealth propagate to consumption. Such propagation is nontrivial when the marginal propensity to consume (MPC), out of transitory income shocks varies across households.
The study uses available estimates of MPCs to weigh the relative importance of direct and indirect effects on aggregate consumption in the euro area. To gauge the direct effects, it uses, on the one hand, detailed information on households’ asset and liabilities exposed to interest rate risk and, on the other hand, estimates of households’ saving elasticity to interest rate changes. To assess the indirect effect, it combines estimates of the aggregate impact of monetary policy on unemployment and wages with household-level job finding rates.
The results show that low short rates do hurt “savers”, i.e. households owning nonnegligible amounts of liquid assets, via a direct effect—that is, via the reduction in their income from those assets. Low short rates, however, also benefit savers, like all other households, via an indirect effect—that is, the reduction in their unemployment rate and the increase in their labour income. The indirect effect dominates from a quantitative perspective.