Wealth and income inequality are extremely complex problems that could take decades to solve given our nation’s partisan divides. But banking policy expert Karen Petrou offers up a resource she believes offers more immediate relief.
As managing partner of the consultancy Federal Financial Analytics, Petrou is one of America’s most sought-after experts on financial regulation. When she thinks What the Future, she argues that the Federal Reserve has the power and the mandate to change monetary policy to reverse wealth inequality.
MacArthur: In your book you argue that the Federal Reserve is an overlooked source of economic equality. How so?
Petrou: There are many causes of economic inequality in the United States. But no single entity has as much control over economic inequality as a central bank, like the Federal Reserve, because central banks determine how much money moves in any economy and who gets that money.
MacArthur: You posit that the Fed is relying on outdated or the wrong data. What’s the most important data change for the Fed to make?
Petrou: They should see America as it is, not as it was.
MacArthur: What are some steps that you think the Fed can take to reduce wealth inequality?
Petrou: To use better, forward-looking, inclusive data; then normalize monetary policy so that interest rates very gradually start to rise and the Fed’s portfolio goes down. Reinstitute market discipline to remove this giant Fed safety net [the Fed’s $8.5 trillion balance sheet that includes $4 trillion in bond purchases made during the pandemic to support the financial markets] and the various windows the Fed has established to provide it. Also, look at the payment system and the rule book. We’re seeing a rapid development of cryptocurrencies and new forms of finance. While these have a tremendous amount of promise, they also pose a terrific amount of danger, especially for vulnerable households.
MacArthur: Looking ahead to the next three or so years, what’s the most powerful thing the Fed could do to get rolling on this change?
Petrou: They should begin to normalize monetary policy and quickly. They really have to deal with the rapid innovation in the payment system and digital currency. They can’t wait for that to blow up. They have to step in.
MacArthur: Does that include creating a federal digital currency?
Petrou: It’s ultimately going to be. It’s better called the central bank digital currency.
MacArthur: Why is the Fed in the best position to fix this?
Petrou: The Fed has three mandates under law [to conduct monetary policy that promotes maximum employment, stable prices, and moderate long-term interest rates]. The Fed is for full employment, price stability—which means affordable consumption—and moderate interest rates. That is the Fed’s mandate. The best approach to economic inequality is a balanced blend of monetary and fiscal policies, and the Fed is not the sole part of the solution. But it’s the part of the economic inequality engine that can go into reverse the fastest.
MacArthur: What’s the timeframe?
Petrou: This is an embedded problem. You will not reverse American inequality overnight, but if the Fed were to begin to normalize and reduce the power that now underlies markets and makes the rich richer and richer and richer, you would start to see a reduction in inequality in three to five years.
MacArthur: What progress would that make?
Petrou: Reducing the market gains that increase the wealth of the rich. Instead, by normalizing interest rates, we would immediately make it feasible for families that save to be able to amass a rainy day cushion. That happens on day one. If the Fed puts some of that $8.5 trillion of cash it holds back into the economy, you will start to see lending going back to support capital formation such as new plants, new equipment, startups, small businesses. That would have a one- to three-year turnaround in beginning to see improved, lower- wage workers getting jobs that pay them better.
MacArthur: What’s holding the Fed back from doing it?
Petrou: They have sunk enormous amounts of cost into this policy and they believe that it is dangerous to normalize [interest rates]. So they are going on waiting for the very robust growth and low inflation and all of the things they have been saying would lead them to normalize since at least 2008, before they loosen their heavy hand on the market.
MacArthur: How would improving equality impact the future of wealth?
Petrou: By definition, if you have less economic inequality, you have more shared wealth. There’s no way you would have necessarily less wealth.
MacArthur: It sounds like you don’t think that cryptocurrencies have the potential to be a wealth equalizer.
Petrou: I don’t. First of all, they play no real role in supporting capital formation: funding of the plants, the equipment, the startup businesses or local new restaurants.
MacArthur: And the way to change that is through the central bank?
Petrou: I don’t know that you need to change that. The next question, which is a different question, is, should there be a central bank digital currency because the nature of currency is changing to be increasingly digital? The answer to that is yes. We have an increasingly digital commerce system, which is far less able to rely on physical cash and old payment instruments like checks or even cards. The role of the Fed also as regulator of the payments system requires it to ensure that in the transition to a digital currency, the private digital currencies that come up do not put vulnerable households or the payment system at risk.