June 26, 2014
St. Louis Fed President James Bullard addressed three questions concerning U.S. monetary policy and income inequality during a Council on Foreign Relations event. He discussed whether quantitative easing affects income inequality, the impact a higher inflation target may have on the poor, and whether current monetary policy hurts savers.
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Full text of remarks:
Income Inequality and Monetary Policy: A Framework with Answers to Three Questions1
James Bullard, President and CEO
C. Peter McColough Series on International Economics
Council on Foreign Relations
New York, N.Y.
June 26, 2014
Three Provocative Questions
Concerns about economic inequality have been voiced throughout history—Thomas Malthus, David Ricardo
and Karl Marx were among the first but they had little systematic data with which they could work. In the 20th
century, the advent of national income, tax return and other economic data have allowed for a more rigorous
analysis of the issues surrounding inequality. Generally, the focus has been on income inequality, but wealth
and consumption inequality are of much interest as well—consumption might ultimately be a more useful
variable for assessing economic well-being. Estimates suggest that wealth is much more concentrated than income
in the U.S. Consumption inequality is generally thought to be less than income inequality. So the ranking seems
to be: The wealth distribution is the most unequal, the income distribution is somewhat less unequal, and the consumption distribution is even less unequal.
Virtually all research shows that U.S. income inequality has increased over the past three decades, but there
is much disagreement over the extent of the increase. Major disagreements and controversies arise from different
income measurements—pre-tax vs. after-tax vs. after-tax plus in-kind benefits; annual vs. lifetime earnings.
A clear message is that measurement matters.
Research also shows that income inequality across countries is considerably more pronounced than within the
U.S. Moreover, over the past 50 years, income inequality across countries has declined if one weights countries
by their populations. Rapid growth in China, India and elsewhere has reduced global income inequality and lifted
many millions out of poverty. For today, I will focus on wealth, income and consumption inequality in the U.S.,
which is where much of the recent debate has centered.
According to a January 2014 Gallup Poll,2 two of three
Americans were either somewhat or very dissatisfied with the distribution of income and wealth in the U.S. This
dissatisfaction has led to opinions that government should pursue policies to reduce the income gap between rich
and poor. A recent CNN/ORC International Survey3 found that
nearly 70 percent of respondents felt that government should work to substantially reduce the
What might these policies look like? What role might monetary policy play in this debate?
To focus our attention, I thought I would outline three provocative questions concerning monetary policy and
income inequality that have repeatedly been asked in the rousing public debate over monetary policy options in
the past five years. To keep suspense at its very peak, I do not plan to provide my answers to these provocative
questions until the very end of the talk.
Here are the three provocative questions: (1) Does the Federal Reserve's quantitative easing program
exacerbate income inequality in the U.S. by putting upward pressure on equity prices? (2) Would a higher
inflation target in the U.S. help or hurt the poor? (3) Does current monetary policy hurt savers?
Interesting questions indeed. We need a simple way to think about these issues before some tentative answers
can be provided.
My preferred framework to approach these questions is a simple modification of a life cycle economy, and
so I plan to talk through some of the nice features of thinking of the macroeconomic world using this approach.
The life cycle model is a workhorse within modern macroeconomics, although it has been less popular in the past
three decades than its single household cousin, the representative agent model. The chief advantage of the life
cycle framework is that, like the real world, it has plenty of heterogeneity—many different households
making many different economic decisions. It also provides a natural and realistic setting for household borrowing
and lending, an essential feature if we are to understand the impact of monetary policy on credit markets.
For our purposes here, I can describe the basic outline of this famous framework in just a few sentences. The
life cycle concept is that people begin to enter the part of their lives where they make independent economic
decisions in their late teens or early 20s. They then live quarter by quarter, making economic decisions about
how much to work, consume, borrow and save. They do this until death, which in the U.S. averages around age 80.
When people die off, they are replaced in the economy by new entrants, in such a way that, in the simplest
versions, the total population remains constant.
The key aspect of the framework for our purposes is the following: Labor productivity varies over the life
cycle. We can think of each person as entering the economy with a given life cycle productivity profile which
is initially near zero, rises to a peak in the middle of adult life, near age 50, and then declines again to
a value near zero. Each person can sell the productivity they have at a particular point in the life cycle in
a labor market at the competitive wage per productivity unit, producing income. However, those at the beginning
and the end of the life cycle will have very little productivity to bring to the market and hence will have
low incomes, while those in the middle of life have a lot of productivity to bring to the market and thus
have relatively high incomes. This latter group will be in their "peak earning years." Given these basic
features, we will necessarily observe income inequality.
One hardly needs a background in economic theory to accept the basic outline I have just given. Indeed, nearly
all participants in the U.S. economy understand at an intuitive level that their ability to earn income will
vary substantially as they age.
Income and Wealth Inequality
Very simple versions of this type of model can generate substantial income and wealth inequality without
adding anything further to the analysis. Consider the case where the productivity profile begins at zero,
rises linearly to a peak at one, and then declines linearly to zero.5
In this special case, 50 percent of the population would earn 75 percent of the income, that is, there would be
a lot of income inequality as an ongoing feature of the economy. In addition, only 25 percent of the population
would hold 75 percent of the net assets as an ongoing feature of the economy. Fifty percent of the
population—the relatively young—would hold no net assets at all, but would instead be net debtors.
Wealth inequality would therefore be substantial and would be even greater than income
These types of statistics have a broadly similar flavor to the ones discussed in the contemporary income
and wealth inequality debate in the U.S. Yet, while all the figures I cite above are true, there would actually
be no income inequality in this economy at all. People are at different stages of the life cycle, and taking
a picture of income earners at a point in time—as the figures cited above do, or as a Gini coefficient
does—reflects the different productivity inherent in the life cycle. For 20-year-olds their peak earning
years are ahead, for 50-year-olds the peak earning years are at hand, and for 80-year-olds the peak earning
years are in the past. These people have different incomes today. But looking at their lifetime as a whole,
these three groups have exactly the same income if they have exactly the same lifetime productivity
Benign Income and Wealth Distributions
The point of this is to say that the simplest life cycle framework will naturally generate relatively benign
income and wealth distributions. These distributions will reflect variable labor productivity over the life cycle,
and not more malevolent forces at work. This raises the question of whether the entire observed level of income
and wealth inequality in the U.S. could be due to this benign force at work. In other words, can a life cycle
model like the one I have described generate income and wealth inequality on the scale observed in the U.S.
The answer is that the plain vanilla versions of the model I have described cannot give a satisfactory
explanation of the observed income and wealth distribution in the U.S. A textbook calculation due to Heer and
Maussner (2009) is a sophisticated attempt to find out what a realistic version of this framework has to say
about income and wealth inequality.8 Their calibration of the
model generates an income Gini coefficient of about 0.42. A Gini coefficient is a number between zero and one
indicating the degree of inequality, with zero indicating perfect equality and one indicating perfect inequality.
We want to compare this number with what other researchers think the income Gini is based on U.S. data alone. For
this we can consider estimates by Budría Rodríguez et al. (2002), who suggest the U.S. income Gini
is about 0.55. We conclude that the model falls short of explaining observed U.S. income inequality. Similarly,
Heer and Maussner (2009) find that the wealth Gini generated by the calibration of their model is about 0.58.
Budría Rodríguez et al. (2002) estimate the actual U.S. wealth Gini at 0.78. Thus the model falls
short on this dimension as well. One evidently needs something else, something beyond the simple life cycle
framework, to explain the levels of income and wealth inequality we observe in the U.S. There are many candidates
for this "something else," so I will leave it to you, dear listener, to insert your favorite villain
Still, let's not be too dismissive. The basic life cycle model evidently explains an important fraction of
the observed U.S. income and wealth Gini coefficients. If you will permit taking ratios of Gini coefficients,
the relatively unadorned life cycle model accounts for something on the order of 75 percent of the story of
measured income and wealth inequality in the U.S., according to the estimates above.
One might want to think of the level of inequality generated by the life cycle model, as well as closely
related estimates, as the natural or ordinary level of income and wealth inequality to be expected in a
large capitalist economy with relatively smoothly functioning markets and stable policy. One may want to be
especially careful not to disturb this portion of income and wealth inequality through tax policy or monetary
Why do we want to be careful about this?
It is because this model also has a shocking secret—shocking at least to the uninitiated. The secret
is that smoothly functioning credit markets work to fix the income inequality problem I am describing. If
everyone in this economy were to simply consume according to their income—if there were no credit
markets—people would consume very little early and late in the life cycle and live like kings in the middle.
This means there are powerful incentives for the relatively young—those in their 20s and 30s, say, to
take on debt in order to smooth lifetime consumption. There are also powerful incentives for households in
their peak earning years to save in order to move income into their retirement years. This happy coincidence
creates a market, a fact that forms the foundation of U.S. household credit markets.
How large is this market in the actual U.S. data? According to Mian and Sufi (2011), the household debt-to-GDP
ratio in the U.S. has ranged from about 1.15 to 1.65 in recent years. In today's dollars, this would amount
to something on the order of $19 trillion to $28 trillion.10
That's trillion with a capital "T." So these markets seem to be large indeed, much of it mortgage debt being
incurred by the relatively young in order to move housing services consumption forward in the life cycle.
This borrowing simultaneously helps peak-earning saver households move income into retirement years where they
will need it.
The secret really hits home if you are willing to make enough simplifying assumptions to really get to the
core of what this model says about income inequality: In the simplest and most transparent version of the
model,11 all households alive at a point in time would consume
exactly the same amount, even though their incomes are radically different. A smoothly functioning credit market
would completely solve the income inequality problem I am describing. Consumption inequality would be zero, and
so the consumption Gini would be zero. This would be about the best outcome one could hope for, because it would
mean that even though income varies widely by household, and even though asset holding differs even more widely
by household, actual consumption would even out completely. To the extent that credit markets are doing their
job reasonably well, one would not want to distort this life cycle allocation process, and hence one might want
to be very careful in trying to design fiscal or monetary policies that might impact U.S. credit
All very well in theory, you say, but is this really what is going on in the U.S. economy? Certainly not in
the very extreme form I have described. Still, the life cycle model does tend to predict a lower consumption
Gini coefficient relative to the income or wealth Gini, which is true in the U.S. data. This suggests that the
framework has some merit. Observed credit markets are surely facilitating considerable consumption smoothing over
the life cycle.
In the beginning of this talk, I said that income inequality has been rising over time in the U.S. Could this
also happen in a life cycle framework? It certainly could. One might think that those at the very beginning or
end of the life cycle are relatively unproductive today, and this situation will not change much over the next
50 or 100 years. For peak earners, however, new technology will likely increase productivity, leading to even
higher life cycle peaks in income than we see today. In other words, future technological change will likely
benefit the highest income earners rather than the lowest, increasing income inequality. Variations on this
theme go by the name of skill-biased technical change in the macroeconomics literature. Recent research by
Lansing and Markiewicz (2014) provides a detailed model of how skill-biased technological change can explain
increasing income inequality in the U.S. in recent decades. Interestingly, the model suggests all households
benefit from the skill-biased technical change, not just those who enjoy higher incomes.
Non-Life Cycle Households
I said that one needs more than the unadorned life cycle model to understand income and wealth inequality in
the U.S. What might we add to the simplest versions of the model? There are many possibilities. Decisions to
acquire human capital, for instance, would be an excellent addition to the model. We could understand how and
why the relatively young might or might not invest in education and thereby increase income (or not) in their
peak earning years. In addition, actual borrowing and lending goes through intermediaries, and the U.S.
intermediation system has been rocked with controversy since the financial crisis of 2007-2009. Surely a
realistic intermediation sector, with all its many dimensions, is important.
But let's focus.
For the purposes of this talk, I want to stress just one addition. It is that not all households in the U.S.
are likely to be well-described by the "work every day," "plan-out-your-life" aspects of the life cycle model.
Many households instead struggle with attachment to the labor force, working only intermittently, and earning
income where and when they can. These households generally tend to have lower incomes, and tend to suffer longer
and more frequent bouts of unemployment. Their life cycle plans can frequently be derailed. This group of people
tends to rely much more on cash than the life cycle group. Yes, life cycle borrowers and savers use cash and other
forms of money, but their most important transactions are accomplished through credit markets. The non-life cycle
group uses cash to get by every day. We might proxy this group by the unbanked. According to some accounts, the
percent of U.S. households that are unbanked is perhaps near 10 percent, and the nearly unbanked may add to this
for a total of as much as 30 percent.12 This is essentially
a relatively poor group of households that is heavily reliant on cash.
Suppose we add this group to our model. Now we can answer the three provocative questions posed at the
beginning of this talk.13
Answers to the Provocative Questions
Does quantitative easing exacerbate income inequality in the U.S. by encouraging savers to move into riskier
assets, such as equities? Many have suggested that the FOMC policy of buying U.S. Treasury securities and
mortgage-backed securities has depressed real yields on relatively safe assets and thus encouraged movement
into equities, raising equity prices. It is often said that only 50 percent of households hold equities in the
U.S., and they tend to be the wealthiest households; so this policy is making the wealth distribution more
The life cycle model gives us some perspective on this type of thinking. The framework indeed suggests that
relatively older households—only half the population—should hold the lion's share of assets,
including equities. In my opinion, equity prices have indeed been influenced by quantitative easing. But I
would stop short of saying that this has made wealth inequality worse. The relatively old are going to have
to be the domestic holders of the capital stock of the U.S., and they will sell this ownership on to the next
generation as they exit the economy. Ideally, when each generation is holding the capital stock, they do so at
"normal prices," neither too high nor too low. Actual equity prices were well below normal by conventional
valuation metrics in 2008 and 2009, and they have recently returned to more standard valuations. To me, this
suggests that quantitative easing had no medium-term implications for the U.S. income or wealth
distribution—it is only as good or bad as it was before the
How about the second question: Would a higher inflation target help or hurt the poorest segment of society?
For this question, recall that I added a non-life cycle group to the economy in the previous section. These
households rely on cash for much or all of their financial life. They tend to have lower incomes than the life
cycle households. Higher average inflation is going to damage the well-being of these households directly. They
are holding all of their income each year in the form of cash, unprotected from inflation. A higher average
inflation rate directly reduces the value of their financial wealth. While it is true this part of the population
tends to have longer and more frequent spells of unemployment, monetary policy cannot influence the average
unemployment rate in the medium- or long-term. The answer to this question is that a higher average inflation
rate would hurt this poorest group in the economy.
The final provocative question is: Does current monetary policy hurt savers? Many have argued that FOMC policy
over the past five years has been to keep real interest rates low, and that these low real yields have impaired
the returns of those saving for retirement or in retirement. I have saved this question for last because I think
it is the most difficult of the three I have posed here today. In my opinion, Fed policy generally and quantitative
easing in particular have influenced the real yield earned by savers. The question is then whether the Fed helped
or hurt the situation by pushing real yields lower during the past five years. This hinges on whether credit markets
have been functioning smoothly during the period when quantitative easing has been a popular policy. If credit
markets were working perfectly or nearly perfectly, then the Fed intervention to push real yields lower than normal
was unwarranted and the low real yields were indeed punishing savers. My University of Chicago economics instincts
give some credence to this view. At the same time, it seems odd to argue that credit markets were working perfectly
or nearly perfectly over the past five years, in the aftermath of one of the largest financial crises the country
has ever experienced, and one that was largely driven by mortgage debt run awry. The policy of the FOMC has been
that, on balance, low real yields will help repair the damage from the crisis more quickly, and I have largely
sided with the Committee in this judgment. As time passes, however, it becomes more and more difficult to argue
that credit markets remain in a state of disrepair, and thus harder and harder to justify continued low real
I hope these answers are as provocative as the questions. I appreciate your kind attention and I look forward
to taking your questions.
I thank Cletus Coughlin for assistance in preparing these remarks. Any opinions expressed here are my own and do
not necessarily reflect those of others on the Federal Open Market Committee or the Federal Reserve System.
[back to text]
2 See http://www.gallup.com/poll/166904/dissatisfied-income-wealth-distribution.aspx. [back to text]
3 See http://cnnpoliticalticker.files.wordpress.com/2014/02/rel3d.pdf. [back to text]
4 This response finding seems to take for granted existing policies, such as progressive taxation, which have been designed to help mitigate income inequality. [back to text]
5 To be more specific, I would have to list many additional assumptions. Those interested in more details may wish to consult Bullard (2014). [back to text]
6 This statement equates the wealth distribution with financial asset holding. This will keep the discussion in this speech consistent with popular discussions of wealth. In macroeconomics, the "wealth of the nation" is the value of the physical capital stock, or, in more sophisticated versions, the value of the physical and human capital stocks added together. [back to text]
7 This statement assumes no ongoing economic growth. If there were ongoing growth, the person born later is richer, but most of the contemporary discussion of income inequality is not about this type of inequality. [back to text]
8 See Chapter 10.2.2., p. 540 in Heer and Maussner (2009). [back to text]
9 One intriguing candidate for a villain has recently been put forward by Greenwood et al. (2014). They investigate how assortative mating—that is, highly educated people marrying other highly educated people—has contributed to increased household income inequality in the U.S. during the post-war era. [back to text]
10 For background on how household balance sheets were affected by the financial crisis and related issues, see the St. Louis Fed's Center for Household Financial Stability: http://www.stlouisfed.org/household-financial-stability/. For additional discussion on income inequality, see an upcoming article by Chris Waller and Lowell Ricketts in the Federal Reserve Bank of St. Louis' The Regional Economist. [back to text]
11 See Bullard (2014). [back to text]
12 See FDIC (2012). [back to text]
13 For more perspectives on the intersection of monetary policy and income inequality, interested readers may wish to consult Coibion et al. (2012), Romer and Romer (1998), Gornemann et al. (2012), Airaudo and Bossi (2014) and Gottlieb (2014). [back to text]
14 For a sophisticated variant of this thinking generally supporting quantitative easing, see the life cycle analysis of Glover et al. (2011). [back to text]
Airaudo, Marco and Bossi, Luca. "Trickle-Down Consumption,
Monetary Policy, and Inequality," unpublished manuscript, University of Pennsylvania, 2014.
Budría Rodríguez, Santiago; Díaz-Giménez,
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of Earnings, Income, and Wealth," Federal Reserve Bank of Minneapolis Quarterly Review, 2002,
Bullard, James. "Discussion of Kevin Sheedy, Debt and Incomplete Financial Markets," Brookings Papers on Economic Activity, forthcoming, 2014. The related presentation is available here.
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