QE & Inequality

I believe that the policies we have undertaken have been meant to generate a robust recovery.1

Effective demand is dead in the water.2

Quantitative easing…is that, like, making math easier?3

For normal people with more interesting lives, I imagine articles headlined with the words “quantitative easing” prompt a mild degree of nausea and / or disinterest.  As for me, for the last six years4 I’ve found it hard to avoid reading pieces on the unparalleled series of unconventional monetary policies: QE 1, QE 2, Operation Twist, QE 3.  So much juicing of the financial markets, so much time I will never have back, so many unintended consequences nobody can foresee.

How is this a question?

Reasonable people can disagree over the merits, scale, frequency and duration of QE policies.  The hypotheticals of what would have happened to the global economy without 3.5 QEs are irrelevant — nobody knows the answer.  The ultimate impact on the real economy seems to have been muted, as here we are six years later facing feeble aggregate demand.  The impact on financial markets, however, has been profound.

And here is where we come to the irrefutable fact: QE increased inequality.  How do we know?  By looking at inputs, initial conditions and outcomes.

Inputs: Trillions of Dollars and The Wealth Effect

Since early September 2008, the Federal Reserve’s balance sheet has increased by roughly $3.6 trillion (an increase of ~4x in size).  In its quest to ease financial conditions and thus stimulate the economy, an explicit objective of the policy was to increase asset values (e.g., prices of homes and financial assets) and create a “wealth effect,” which basically means people feel richer5 so they buy more stuff.6

It might be helpful to think about how this policy impacts asset values in two stages: the first technical, the second psychological.  For simplicity, we’ll just focus on bonds and stocks, and leave out the agency debt and mortgage-backed securities activity (see exhibits below at right; click to enlarge).

Stage 1 – The Alchemy of Finance

So under quantitative easing, the Fed literally bought U.S. Treasury bonds, which—all things equal—leads to an appreciation in bond prices (because more demand increases prices) and a reduction in interest rates (because bond prices and interest rates move in opposite directions).7  Since U.S. Treasurys are frequently used as a reference and discount rate for other securities, what this policy effectively did was bring future earnings / return streams forward to the present.  Bond and stock prices went up—catalyzing that wealth effect—and interest rates went down.

For Beginners

Stage 2 – Animal Spirits

In the years to come, academic economists will spend countless man-hours running regressions and hypothesizing correlative and causal relationships between QE and asset prices.  Maybe one day there will be a data point proving it all.8  In practice, QE—and QE 3 in particular—morphed investor psychology.  The growing awareness of a “Bernanke Put” prompted a ravenous search for yield that has pushed U.S. stocks to all-time highs, and led to zany behavior in every corner of financial markets.  The list of examples would be too long to include here.

For Amateurs

Initial Conditions: Cui Might Bono?

Now, to get a sense of who would benefit from a policy in which stock and bond prices would appreciate in value, it helps to know who owned stocks and bonds ex ante.  Every three years since 1983, the Federal Reserve has run a Survey of Consumer Finances.  The most recent survey was in 2013.

Before the world economy nearly imploded, it was fairly clear who might benefit from an inflation in asset prices.  The Fed’s survey data of asset ownership in 2007 show that those who were in the top 10% of incomes, those who had college degrees, and those who were white were most likely to enjoy the wealth effect (see exhibits below; click to enlarge).9  As Tom Friedman might say, a rising tide lifts all boats, but some boats are more equal than others.

Asset Ownership by Income (2007)

Asset Ownership by Education (2007)

Asset Ownership by Race (2007)

Outcomes: Rich Got Richer, Everyone Else Stood Still or Fell Back

How’d we do, team?  Since data were missing from the Fed’s pooled investment fund segment, I’ve focused on the performance of retirement accounts (see exhibit below; click to enlarge).  As expected, those in the top decile of incomes and white people were more likely to come out ahead.  With respect to education, those who had at least some college education were likely to benefit.

Retirement Savings


Not to suggest it’s related to QE, but this is quite the kicker.  If you exclude the wealth effect, and just look at how incomes have fared over the last few years, the only people who haven’t experienced a real decline in earnings are those in the top 10% of incomes.  There is a fair bit of data in the table below; I would simply draw your attention to all of the minus signs in columns four and seven before one comes to the top decile of incomes.


Who’s to Blame?

It’s easy to blame the Fed for all this inequality, but it’s not entirely their fault, and it’s certainly not their job to fix it.  In the face of a depression, deflation and massive deleveraging, they saw a need to keep the foot on the accelerator.  Where, one might wonder, was the fiscal side in all of this?

I think most would agree that Congress has done little to nothing with the fiscal lever of policy at a time when borrowing costs have been quite low.  Those who are angered at the inequality birthed by QE may wish to consider why Congress has refused to pursue expansionary fiscal policies that could have put more people to work, provided long-term structural competitive advantages for the United States, and bolstered aggregate demand.

Or perhaps consider why Congress has not debated whether a modicum of redistribution from capital gains might be appropriate given the fact that QE would inherently exacerbate inequality in a way that brought rewards not for hard work and creating value, but simply for those citizens who owned assets to begin with.  Statesmen and citizens alike might wish to ponder whether this is a just outcome befitting of the society in which they wish to live.

À Bientôt

The riskiest thing in the world is the widespread belief that there’s no risk…While investor behavior hasn’t sunk to the depths seen just before the crisis, in many ways it has entered the zone of imprudence…Today I feel it’s important to pay more attention to loss prevention than to the pursuit of gain.10

We’ve never had any experience with anything like this, so I’m not going to sit here and tell you how this will turn out…I don’t think it’s possible [to exit QE without turmoil]…[When real interest rates go up, for whatever reason] it is basically [going to be] a very significant decline from an extraordinarily elevated equity premium.11

If you managed to benefit from QE, congratulations!  As the data show, many of your fellow citizens didn’t, so be grateful.  I was not 100% fully invested in stocks for the duration of QE so I missed out on some free money.  Tant pis.  Couldn’t care less, really.

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11 Greenspan, op. cit.


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