In widely circulated remarks, Federal Reserve Chairman Jerome Powell recently stated that the Fed’s COVID-19 response is “absolutely not” contributing to income inequality. But our data indicate that Powell’s statement is absolutely wrong. We propose an alternative policy that addresses the underlying source of the economic decline while seeking to ensure greater equity in who benefits from the Fed’s actions. We combine a bit of common sense with a radical departure from Fed policy through stimulating the economy by supporting consumer credit not corporate credit.
Since March, the Fed has printed and spent more than $2.9 trillion — about $22,000 per U.S. household, purchasing a variety of securities in an effort to keep interest rates low and stimulate the economy. The key assumption is that low interest rates will stimulate corporate spending, which will “trickle down” to labor markets, stimulating employment. There are two problems with this approach in the current environment:
- Drop in Demand: The current slump in the economy is the direct result of a record drop in demand due to the coronavirus pandemic. It was not caused by an absence of cheap credit. No matter how much money the government uses to subsidize corporate credit markets, why would corporations spend money producing goods and services if the customers (literally) stay home? For example, Boeing raised $25 billion in the bond market at ultra-low rates. But only weeks later it laid off 10 percent of its workforce. Is it any surprise that demand for airplanes is down? Unfortunately, this type of behavior is more the norm than the exception: Many companies are using proceeds from government-subsidized bond offerings to create “war chests” of cash rather than spending the money to stimulate labor markets.
- Frozen Consumer Markets: The good news is that the Fed’s actions have stabilized the mortgage market: Homeowners can still refinance at record low rates. The caveat is that these low rates disproportionately benefit those capable of refinancing — a demographic that skews toward high-income homeowners. Indeed, major lenders have significantly tightened credit standards. For example, Wells Fargo and Chase, two of the largest home lenders, have suspended offering home equity loans and have significantly raised minimum credit scores. As banks tighten their consumer lending, it limits the extent to which the middle-class can benefit from Fed actions to keep rates low. Unemployed due to COVID-19 but with substantial home equity? Sorry. Refinancing is not an option.
So, where does all the Fed money go if it isn’t trickling down to labor markets and consumers? It is being reinvested in financial assets, inflating their value. This explains why we are facing record unemployment not seen since the 1930s, but yet equity valuations are now higher than they have been at any time over the past 15 years.
Thus, Fed policies are failing to bring down unemployment while simultaneously inflating financial asset values. As such, they are having a profound effect on the distribution of wealth. Individuals working in jobs that pay less than, for example, $40,000 a year face a double whammy.
First, they are more likely to be unable to work from home, and as a result face 40 percent unemployment in this environment. Second, such individuals rarely have any investments, either directly or indirectly through retirement savings. They do not participate in the Fed-induced market rally. Thus, in contrast to Powell’s claim, the Fed’s policies leave behind those most affected by the crisis – lower-incomes workers – and disproportionately benefit those least affected by the crisis.
A different crisis calls for a different response. Rather than relying on policies from the 2007-2008 playbook (that low interest rates in the corporate credit market trickle down to labor markets), the Fed should write a new playbook and focus on consumer credit markets. Under the Term Asset-Backed Securities Loan Facility (TALF), the Fed is authorized to purchase (technically, accept as collateral) $100 billion of consumer loans, but only AAA-rated loans. We propose that the Fed expand its consumer loan programs to include lower-rated (even junk-rated) consumer loans and unsecured loans. A risk-sharing arrangement between the Fed and lender banks for unsecured loans would substantially lower the rate on these loans and provide access to capital for the most disadvantaged individuals.
This program would help both homeowners and renters get cheap consumer financing. It would also allow the Fed to address the underlying source of the economic decline – a record drop in consumer demand – while ensuring equity in who benefits from Fed policies. The Fed argues that it is purchasing junk bonds to subsidize credit to corporations that don’t have an alternative source of credit. So why not subsidize credit to consumers who don’t have an alternative source of credit?
But what about the Main Street Lending Program that was just announced? Surely it targets Main Street America, right? Read the fine print. No “Main Street” company we know has billions in revenue or thousands of employees. Our idea: Create a lending program that supports consumer loans, loans that allows income-strapped consumers to continue to pay their rents, continue to make their mortgage payments and continue to consume goods and services offered by the real Main Street.
The Fed can print and allocate money to whomever it wants (within the restrictions of its charter). We see little evidence to suggest it is acting in the interest of large segments of public. And more concerning, there is no mechanism that would discipline its behavior short of voters calling for Congress to enact political oversight.
Chairman Powell and the Fed need to be significantly more sensitive to consumers and consider income inequality in their policy decisions. Otherwise, the wave of populism hitting the U.S. will only grow, posing an existential threat not only to Fed independence but to the free-market system as a whole.
Thomas Lys is a professor emeritus at the Kellogg School of Management at Northwestern University. Daniel Taylor is an associate professor at the Wharton School of the University of Pennsylvania.