Central banks are currently hiking interest rates to reduce aggregate demand. How is this reduction in spending distributed across the population? Specifically, what would be the shape of a graph of spending reduction vs income percentiles? (Also, would the curve differ qualitatively between countries?)
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2$\begingroup$ I do not think this can be done or even makes sense. To start with, aggregate demand is not just demand of individuals but demand of government and even foreign demand from abroad. Also aggregate demand is not being distributed among individuals, I don't even know what to make of the phrase that aggregate demand is being distributed it makes no sense. Also, how can be demand progressively or regressively distributed? Is having low demand regressive? $\endgroup$– csilviaJul 19, 2022 at 20:21
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1$\begingroup$ @csilvia: The current version is a very valid question (not sure about earlier edits). This is actually a big research area. If you search "Monetary Policy Inequality Distribution" on google scholar it will give you 1.7 million hits. Central banks themselves are actually looking at this, because it may affect monetary policy transmission. $\endgroup$– BrsGJul 19, 2022 at 20:32
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$\begingroup$ @BrsG yes for relationship between monetary policy and inequality, not between monetary policy and > > aggregate demand distribution < <. From the current edit it is not clear if the user asks about income inequality or wealth inequality or some entirely different concept altogether. Effect of monetary policy on wealth or income inequality is valid question, effect on aggregate demand inequality makes no sense $\endgroup$– csilviaJul 19, 2022 at 20:35
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1$\begingroup$ @csilvia: well, aggregate demand has to suffer when central banks raise interest rates to fight inflation. The question seems to be about which income type househlds suffer to which degree, which I think is a valid question. $\endgroup$– BrsGJul 19, 2022 at 20:41
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$\begingroup$ @BrsG right but aggregate demand itself is not distributed, I think you are making up better question in your head, inspired by OP question, but that is not question OP actually asked $\endgroup$– csilviaJul 19, 2022 at 21:36
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2 Answers
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I am not sure if I understand the question. If you ask if interest hikes increase inequality, the answer is no.
It is not fully clear if there is any strong relationship between monetary policy and inequality, but if there is some relationship it is exactly opposite. Low interest rates make inequality worse$^1$. This is because low interest rates lead to higher asset prices which benefits primarily the rich. Low interest rates also lead to higher house values and rents making it more difficult for poorer people to get housing.
Berisha, E., Meszaros, J., & Olson, E. (2018). Income inequality, equities, household debt, and interest rates: Evidence from a century of data. Journal of International Money and Finance, 80, 1-14.
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$\begingroup$ By assets do you only mean housing? Are you referring to static high prices (due to interest rates below the historical average) as a barrier to ownership? Or do you mean that rising asset prices (due to falling interest rates regardless of absolute level) increases the profitability of capital? And did you account for differences in unemployment (since low interest rates help more businesses to expand)? $\endgroup$– benjiminJul 20, 2022 at 1:25
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$\begingroup$ @benjimin by assets I mean stocks & capital. Rising prices regardless of level, with 0% interest rate any arbitrary high stock price is justifiable since with 0% discount rate the present value of future profits becomes infinite. Everything is accounted for that is data based observation that low interest rates promote wealth and income inequality. That is what data show so all effects are accounted for there $\endgroup$– WilliamTJul 20, 2022 at 8:07
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$\begingroup$ also low interest rates do not help business to expand. For business to expand they need some available capital (machines, factories, cars and so on). Low interest rates discourage capital accumulation so over time capital becomes less available with low interest rates. Also low interest rates do not help unemployment directly, low interest rates cause inflation and high inflation reduces unemployment because in short run Philips curve (trade off between inflation and unemployment) has negative slope. However, in long run Phillips curve is flat so low inflation (caused by low interest rates) $\endgroup$– WilliamTJul 20, 2022 at 8:11
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$\begingroup$ can't have lasting impact on unemployment and conversely, low inflation (caused by high interest rates) can't have lasting impact on unemployment either. In long run the relationship between inflation and unemployment breaks down. $\endgroup$– WilliamTJul 20, 2022 at 8:12
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$\begingroup$ So are you saying that each individual demand curve stays the same regardless of whether the central bank hikes rates or not? E.g. a plot of the change in consumption ($) caused by the hike, versus income percentile, will be zero along the entire x-axis? $\endgroup$– benjiminJul 20, 2022 at 15:55
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“About 10 per cent of the population are set to carry the greatest burden of getting inflation back down for the benefit of everyone else” according to the Australian national broadcaster.