Federal Reserve Chair Janet Yellen has devoted time of late to discussing the significant problem of inequality. At a conference on April 2nd, Ms. Yellen urged that research be undertaken “to understand whether any policies may hold people back or discourage upward mobility.” Perhaps such research might start at the doorstep of the Federal Reserve because the Fed’s sustained policy of near-zero interest rates has increased inequality, as well as made it more difficult for the middle class to climb the economic ladder.
The crux of recent Fed policy hinges on a simple premise: Very low interest rates inflate the value of financial assets like stocks. When interest rates approach zero on ‘safe’ assets, investors must look elsewhere in search of returns. For example, many Americans living on fixed incomes can no longer afford to hold their money in savings accounts or CDs. Instead, for potential gains, they are forced to look to riskier assets like stocks.
Not surprisingly, the stock market has boomed. In 2013, the U.S. economy grew just 2.2 percent, yet stock prices rose more than 28 percent in real terms. This means that the stock market grew 13 times faster than the economy, the highest ratio since the abandonment of the gold standard in 1971. In 2014, stock prices grew five times faster than the economy.
This increase in asset prices has pushed household net worth to an all-time record of $83 trillion. But because the benefits of asset inflation are so unequally distributed, the wealth gap has also widened to all-time records. In the U.S., the bottom 50 percent of the population own just 1 percent of the country’s net assets. The top 10 percent own 75 percent, making them the chief beneficiaries of the booming stock market.
Through this lens, the Fed’s broad gauge of inflation fails to account for the two-track economy that its policies have helped create. Thanks to technological advancement and low-cost imports, most goods that Americans consume—consumer staples, electronics, textiles, and nutritional food—have actually become more affordable over the last decade. But services that rely heavily on skilled labor have in many cases have become increasingly unaffordable; education—particularly higher education—is illustrative. Tuition costs have risen by more than 50 percent in real terms over the last decade amid flat wages and declining per capita income.
Asset-holders have been able to take the tuition hikes in stride because over the same period, the S&P 500 returned more than 70 percent in real terms and net assets more than doubled. But Americans reliant on wages have been forced to take on a raft of debt to absorb the increased costs; student loan debt has nearly quadrupled to $1.3 trillion since 2004. And despite all of this debt, according to the most recent Bureau of Labor Statistics (BLS) report, the top-fifth of earners still spend four times more per capita on education than all other Americans surveyed.
Education is the modern-day pillar of the American dream and the key to social mobility: Professional degree holders earn three times more than those who never attended college. So, as education becomes increasingly unaffordable for most Americans, what is the Fed’s solution? It is attempting to push prices even higher with continued ultra-low interest rate policy.
The primary justification for such action is the inflation prong of the Fed’s dual mandate. The unemployment rate has improved significantly in recent years but price growth has remained below the Fed’s targeted 2 percent level for 34 consecutive months. The Fed has surmised that continued low interest rates and resultant asset inflation will encourage Americans to spend more and, in turn, increase price growth.
But there is a big problem: The broader price measure ignores the bifurcated economy delineated above. With stagnant wages limiting demand and technological improvements lowering prices, inflation in most goods will remain sluggish. Instead, eternally low interest rates will push the prices of the services most important for economic advancement, like education, even further beyond the reach of the middle class.
Last October, at the Federal Reserve Bank of Boston, Ms. Yellen stated that, “The past few decades of widening inequality can be summed up as significant income and wealth gains for those at the very top and stagnant living standards for the majority.” If the Federal Reserve continues to pursue loose policy and easy money, it’s likely the next few decades will be summed up similarly.
Matthew Schoenfeld works at Driehaus Capital Management LLC, where he focuses on risk arbitrage and event-driven investing.
