How the Federal Reserve's low interest rates accelerated wealth inequality
Wealth inequality has surged since the 1970s. It has been accelerated recently by the Federal Reserve's actions after the Great Financial crisis by lowering interest rates, which have in turn inflated the prices of assets, mostly owned by the wealthiest Americans.
The fundamental cause is that the lower interest rates push investors up the yield curve. Someone who wants a five percent return per year on their assets could have once found that return via government bonds. Unfortunately, with rates near zero today, that isn't possible.
As such, people move into assets like equities or real estate searching for a higher return. This drives up these assets’ prices - both are at all-time highs today. Only the wealthiest of people own stocks and they have gained the most from low interest rates and inflated asset prices.
For more on how low interest rates inflate the stock market, check out this MeidasTouch story.
But with interest rates at zero, having the majority of someone’s money in a savings account doesn't compound wealth; this, in combination with inflation, actually causes those without exposure to property and stocks to lose money year over year.
American workers are not able to invest a sizable portion of their savings into the stock market considering they might not know when they will need the money for expenses.
To show the stark divergence, here is how $10,000 would grow if it was in a low-yield savings account, high-yield savings account, or in the SP500.
$10,000 in a savings account for 40 years at 0.2% interest = $10,832
$10,000 in savings account for 40 years at 5.0% interest = $70,400
$10,000 invested in the S&P 500 for 40 years at 10.0% return = $452,593
In 2000, the federal funds rate was 6.24 percent - it now sits at 0.08 percent.
The actions of the Federal Reserve also increase the racial wealth gap as white families, on average, own more stock than black families:
"In a low interest-rate environment, Black households experience a gain in income -- owing to better job opportunities -- equivalent to 0.19% of annual income," said Bloomberg's Catarina Saraiva. "The capital-gains benefits of an increase in things like equity prices result in a gain equal to 24% of annual income for White households versus 6.5% for Black households. That 17.5 percentage-point gap is two orders of magnitude larger than the 0.19%, the paper’s authors found."
A paper written by Alina Bartscher from the University of Bonn and New York Fed economist Moritz Schularick came to a similar conclusion:
"Over multi-year time horizons, the employment effects are substantially smaller than the countervailing portfolio effects. We conclude that there is little reason to think that accommodative monetary policy plays a significant role in reducing racial inequities in the way often discussed. On the contrary, it may well accentuate inequalities for extended periods."
On top of all this, wage growth in America has basically ground to a halt since the 1970s despite the consistent growth in national productivity year over year.
There is an entire generation of American workers who haven't been able to take advantage of the low interest rates and subsequent asset appreciation, because they aren’t being paid enough to cover their living expenses, let alone invest in the stock market.
A major reason for that lack of wage growth has been the collapse of unions. As you can see in the graph below, unionization rates have dropped over time. This happened concurrently with the decrease in hourly compensation for workers (see above). The wealth of the richest Americans increased dramatically at the same time.
In combination with said stalling American wage growth, the Federal Reserve’s insistence on artificially pinning rates at historic lows has exacerbated the already extensive wealth gap that has been growing since the 1970s.
While recent monetary policy may have been necessary to avoid a stock market collapse which would lead to massive job loss (more than now), the Federal Reserve’s decisions have undoubtedly increased the wealth gap.
In order to reverse the consequences of low interest rates and address the wealth inequality that has been growing for the last five decades, the government must enact fiscal stimulus to improve wages for workers, enact policies that make it easier for workers to own assets that provide generational wealth, and redistribute wealth through a progressive tax system.
President Joe Biden has taken one step in the right direction by supporting a minimum wage increase to $15 an hour, however, that is just one step of many necessary steps that need to be done.
Another step in the right direction could come from a Biden stimulus plan that creates hundreds of thousands, if not more, of well-paying jobs building American renewable energy infrastructure.
The emphasis on renewable energy will help replace the five million manufacturing jobs that have been lost since 2000, redistribute wealth by rebuilding an American middle class, and fight climate change. All of which will help reduce wealth inequality.
The graphs used in this article are from Inequality.org and the Economic Policy Institute.
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About Ryan Lipton:
Ryan is a recent graduate from the University of North Carolina at Chapel Hill and majored in Business Journalism. He has written in the past for SB Nation's Silver and Black Pride, USA Today Sports Media Group, North Carolina Business News Wire, the Daily Tar Heel, and has worked with Ice Cube's BIG3 basketball league.