Given monetary policy’s inadequacy in addressing structural factors, the aff’s fiscal reform is key

“2021 Annual Economic Report,” Bank for International Settlements, June 2021, https://www.bis.org/publ/arpdf/ar2021e.pdf

Conclusion

Inequality is largely the result of long-term structural forces that are independent of monetary policy. Over the past few decades, globalisation and technology have played a prominent role. Policies that foster more equal opportunities or redistribute income are best suited to counteract the impact of long-term forces on income and wealth inequality. Structural policies, including those targeted to education, health and competition, give the relatively poor of today the instruments to become the well-off of tomorrow, promoting social mobility and equitable growth. Fiscal policies, notably through redistribution, help correct the uneven distribution of the aggregate gains from growth.

Monetary policy does not have adequate tools to offset the long-term distributional consequences of evolving structural factors. Nevertheless, depending on statutory responsibilities, central banks can make a significant contribution by wearing their “non-monetary hats”, to an extent that depends on the tools available. Promoting financial development, inclusion and literacy, protecting against unfair financial practices, and furthering low-cost payment services all contribute to a more equitable society.

This is not to say that monetary policy cannot foster a more equitable society; far from it. Monetary policy can make an important contribution by keeping the economy on an even keel in fulfilment of its mandate, ie by tackling macroeconomic, including financial, instability. Macroeconomic instability can have a first-order impact on inequality over business cycle fluctuations. The two major forms of instability are high inflation, which disproportionately erodes income of households at the bottom of the distribution, and recessions, which hurt the poor through unemployment spells.

Changes in the nature of the business cycle over the recent decades have complicated monetary policy’s ability to counteract macroeconomic instability and its impact on inequality. To be sure, inflation has largely been conquered – a major achievement. But financial factors have come to the fore as a key force amplifying business cycle fluctuations. Financial recessions tend to be deeper and longer, especially if a financial crisis breaks out, and therefore much more costly in terms of inequality. Moreover, they require the central bank to keep interest rates low for longer to nurture a recovery: by boosting asset prices, especially those of equities, this may raise wealth inequality in the short run even as it delivers substantial benefits by bolstering employment and reducing income inequality. The intertemporal trade-offs that arise pose a key challenge. With inflation less responsive to economic slack, the central bank can keep the monetary policy stance easier for longer. This brings more people into the labour force, supports employment and reduces inequality. But it may also contribute to a slow build-up of financial imbalances that sow the seeds of costlier financial recessions down the road.

In order to better address these trade-offs, a more balanced policy approach is needed. Prudential, fiscal and structural policies are important in this context, as part of a comprehensive macro-financial stability framework.