Quantitative Easing and Income Inequality

Ever since quantitative easing has been implemented as a mainstream policy, Central banks have had to fend off charges that it is leading to increased income inequality. The central banks have been alleging that quantitative easing has not created more income inequality. They often cite the low inflation figures as proof of this claim.

In this article, we will have a closer look at how quantitative easing has influenced the wealth gap.

Quantitative Easing and Inflation Figures

Firstly, it is important to understand that quantitative easing puts more money in the hands of the rich. This is because this policy implies a massive amount of asset purchases by the government. These assets are obviously held by the wealthy people of that state. Hence, quantitative easing is an exercise of transferring money from the government to the wealthy. Since the government derives most of its money from the middle class, quantitative easing essentially transfers money from the poor to the wealthy.

Now, the poor spend a higher percentage of their income on consumption. On the other hand, the rich do not have a high marginal propensity to consume. This means that they spend a smaller percentage of their income on consumption and a larger percentage of savings and asset creation. If we look at the inflation patterns in the recent years, they seem to be consistent with this.

For instance, the cost of living has not gone up very high. However, on the other hand, asset prices have skyrocketed. The logical explanation is that the rich have not spent much of their money on consumption. However, they have created a bull run in most property markets. Since this money came into the hands of the rich because of the government’s policy of quantitative easing, the government can and should be held accountable for skyrocketing asset price inflation.

Also, it needs to be understood that the cost of real estate and other assets are not part of any inflation index. Inflation indexes only measure the cost of consumables. As a result, the increasing asset prices are not showing up in inflation indexes. This is allowing central banks to make misleading claims that quantitative easing has not led to any income inequality.

The Old vs. the Young

The government’s policy of quantitative easing has impacted the old and young citizens in very different manners.

• Firstly, young citizens have seen increasing salaries because of quantitative easing. This policy prevented a slowdown which would have inevitably turned into a recession. If there was a recession, there would have been widespread job loss. The recession has prevented job losses and on the other hand has led to marginal increase in salaries.
• Secondly, young citizens have seen asset prices spiral out of control. Hence, even though they have jobs which pay them decent salaries, most of the young entrants in the job market cannot purchase a home. Hence, the negative effect has been quite profound since an entire generation is being prevented from leading a normal financial life.
• From the old generation’s point of view, their income has been reduced because of the implementation of quantitative easing and related policies. This is because these policies have led to a reduction in the interest rate. The elderly derive a large portion of their income from bank deposits, the yield of which is affected by interest rate changes. This may have had a negative effect on some older citizens who have healthcare conditions and therefore need cash for treatments.
• However, the old generation has seen the highest rate of wealth building in decades. This is because most old people are home owners and as already discussed in this article, the housing rates have skyrocketed. Hence, their net wealth has grown at an unprecedented rate making them the biggest beneficiaries of the quantitative easing policy.

What Should Have Been Done?

Quantitative easing has definitely affected the incomes and assets of almost every person. Some people have faced negative effects whereas others have faced positive effects. It is important to understand that in the absence of implementation of these policies, the world was looking at a major financial recession. Given the dire circumstances at the time, it does not seem like the central banks had much choice. Creating wealth inequality via quantitative easing is still a better choice than making everyone poor and hence eliminating the inequality.

However, it seems like the interest rates are likely to rise now. This could trigger another panic like that of 2008. The government needs to learn from its mistakes. It needs to ensure that the money released via quantitative easing does not make its way back to the asset market. Instead, it can be channeled to more productive parts of the economy. For instance, instead of giving out money, the government should give out infrastructure bonds to wealthy investors. The proceeds from these bonds should then be used to create better infrastructure. This will give a boost to job creation and will also prevent unnecessary asset price inflation.

To sum it up, quantitative easing has become a necessary evil. The governments are helpless in front of global scenarios and are forced to use this policy. However, they need to be responsible enough to understand its negative effects and reduce the same.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.