Is the Federal Reserve Contributing to Economic Inequality?

This speech is dedicated to the memory of Thomas Laubach, a devoted public servant and tireless advocate for crafting policy that works for everyone.

Thank you so much for the opportunity to join you today. It means more to me than you might expect.

I’ve spent almost 25 years at the Federal Reserve Bank of San Francisco. And back in 2006, when I was working in our research department, I got a big opportunity. Our president at the time, Janet Yellen, was coming to UC Irvine to deliver a speech on economic inequality right before the midterm election (Yellen 2006).  I had a chance to work on her remarks, and it was a defining moment in my career.

So to be here again, at UC Irvine, as the current president of the San Francisco Fed, delivering a speech of my own on inequality, weeks before another important election, feels like a full-circle moment for me. And I thank you very much for the opportunity.

Now, I’d like to say that we’ve made a lot of progress since Janet’s speech in 2006. But inequality is still a pressing issue for our nation—one that feels even more urgent in the wake of the health and economic hardships caused by COVID-19, and the social reckoning sparked by the deaths of George Floyd, Breonna Taylor, and too many others.

Not every American gets the same chance at life, liberty, and the pursuit of happiness. And this difference in opportunity translates into differences in outcomes. It leaves us with two Americas: one for those who have, and one for those who have not. This is our shared reality, a reality we have to acknowledge and confront—as individuals, as institutions, and as a nation.

As a monetary policymaker and the leader of the San Francisco Fed, I’m frequently—and rightly—asked about how the Federal Reserve contributes to the inequality we observe. So today, I will take this on directly: inequality, the role of the Fed, and how we must collectively move toward a better, more inclusive economic future.

The root of the question

Let’s start by looking at a few recent facts that suggest the Federal Reserve might play a role in generating economic inequality.  

COVID-19 hit our shores in January. And by March, we saw severe impacts on health and economic activity. Both the Fed and Congress took immediate and unprecedented action.  

The Federal Reserve cut the federal funds rate to close to zero and implemented a wide array of measures to facilitate the flow of credit in the economy (Board of Governors 2020a, b).  Congress provided almost $3 trillion in fiscal support to shore up households, businesses, and state and local governments. Together, these measures formed a bridge, helping people and businesses through the immediate economic hardships caused by COVID-19.

But what has happened since then?

As the economy has slowly reopened, employment growth has rebounded, exceeding most expectations. But this growth has erased only about half of the original losses. In September, employment was still down by almost 11 million people from its recent peak. Those are bigger losses than we saw during the Great Recession. In contrast, financial markets have recovered completely. After dropping nearly one-third in February and March, all major U.S. stock indexes have recovered their declines.

Looking at the two recoveries I have just described—the economic one and the financial one—it seems unfair. Another example of Wall Street winning and Main Street losing. Of a few advancing while so many others fall behind (Kuhn, Shularick, and Steins 2020). 

So how do we alter this imbalance? What can we do to ensure the proceeds of economic growth are more equitably distributed in our society?

This is the right question to ask of policymakers. And while I can’t provide a simple playbook or recipe, I will lay out the issues I see before us and discuss what the Federal Reserve, our fiscal agents, and each of us must do if we are going to create a more equitable future.   

This isn’t just a COVID-19 phenomenon

First, it’s important to note that, while COVID-19 has spotlighted and magnified the inequities in our nation, these disparities have existed for decades. Income and wealth inequality in the United States have been rising almost without pause since 1980. Let me offer a few illustrations.

Over the past 40 years, the income of households near the bottom of the distribution—the 10^th percentile—rose by about 20%. In contrast, households near the top of the distribution—the 90^th percentile—saw their incomes rise by 66% (Semega et al. 2020). 

These differences in returns have added up to more inequality. In 2019, the top 10% of adults in the United States took home almost half of the pretax income generated in the economy—nearly five times their share of the population, based on data from the World Inequality Database. 

Looking at wealth, the disparities are even wider. About one-quarter of Americans have essentially no wealth—near zero or even a negative net worth (Bhutta et al. 2020).  The remainder of households have some wealth, but this is quite unevenly distributed. At the end of 2019, the top 10% of American households owned nearly 70% of all wealth held in the United States as calculated from the Federal Reserve Board’s Distributional Financial Accounts.

We’re not the only country experiencing these trends. Inequality has increased in countries with economic systems similar to ours, like the United Kingdom. And it’s also happened, albeit to a lesser extent, in countries with economic systems very different from ours, like Denmark and Sweden (see the World Inequality Database).

A range of structural factors have contributed to the worldwide increases in inequality we observe. These include automation, growing demand for college-educated workers, and globalized labor, product, and capital markets (see, for example, Autor 2019; Nolan, Richiardi, and Valenzuela 2019; and Dabla-Norris et al. 2015).

But global trends alone can’t explain the severe run-up in economic inequality we’re experiencing in the United States. We have additional and unique challenges—struggles we see play out on the news every day.

Systemic biases related to race, ethnicity, gender, and class have led to unequal access to education, jobs, income, and wealth (see, for example, relevant chapters in Nolan, Salverda, and Smeeding 2011; also Aliprantis and Carroll 2019, Butler, Mayer, and Weston 2020).  And these inequities have compounded over generations, as children born into poverty or low-income households carry that disadvantage through to adulthood and pass it on to their children (Bengali and Daly 2013, Chetty et al. 2014).  

These trends—and their persistence over time—reflect fundamental choices we’ve made about public education, taxation, and the social safety net. Fundamental choices about how we manage our society.

So if these are our choices, what can institutions like the Federal Reserve do to change the landscape? The answer is: quite a lot.

Inequality and monetary policy

The Federal Reserve has a dual mandate—full employment and price stability. We achieve these goals primarily by adjusting the short-term interest rate. Our interest rate decisions make it more or less expensive for consumers and businesses to borrow money. This guides spending decisions, which impacts hiring, wages, and ultimately inflation.

When it’s working well, our policies provide the foundation for a positive feedback loop—consumers spend, firms invest and hire more workers, and a wide range of households build income and wealth. This is the virtuous cycle of growth that ultimately delivers a strong, sustainable, and inclusive economy. 

But how do our policies work in practice? To get a sense of this, let’s consider the last expansion—the longest in recorded U.S. history. After taking significant measures to stabilize the economy in the wake of the 2008 financial crisis, the Fed committed to a period of sustained low interest rates to support the labor market and return inflation to 2%.

The benefits were material. The length and strength of the expansion pushed the unemployment rate to near-historic lows. This created real opportunities for a large number of sidelined Americans, many of whom were thought to be permanently out of the labor force or lacking the right skills to work in an evolving job market (Aaronson et al. 2019, Abraham and Kearney 2020).  

By early 2019, employers were hiring African American and Hispanic workers at rates equal to or higher than those of white workers (Petrosky-Nadeau and Valletta 2019). This reduced long-standing unemployment gaps, narrowing them to historic lows. The same thing happened for those with a high school diploma: hiring rates rose, unemployment fell, and gaps narrowed relative to college-educated workers (Aaronson et al. 2019).  

By the end of the expansion, these improved employment outcomes were leading to faster growth in wages and income for less-advantaged groups. Between 2016 and 2019, median wage growth for low-wage workers was more rapid than for high-wage workers, reversing a pattern that had dominated in previous years. This narrowed the relative gaps in wages between those in the lowest earnings quartile and all other groups (Robertson 2019).  

The better-than-average wage growth translated into better-than-average growth in household incomes. In 2019, median household income for Black and Hispanic households rose by more than 7%, compared to less than 6% for white households (Semega et al. 2020).  

Finally, these improvements also showed through to wealth. As the economy continued to expand, so did the value of assets, including housing, businesses, and stock market holdings. Gains on assets were especially rapid for those at the bottom of the wealth distribution (Bhutta et al. 2020).  Between 2016 and 2019, families with the lowest net worth saw the largest growth in their holdings. This late-cycle pattern gave less-wealthy households a chance to reap some of the benefits that had been captured disproportionately by higher net-worth individuals earlier in the cycle.

Now, these are a lot of numbers. But they all point to a single thing: nearly 11 years of uninterrupted growth helped a broad range of Americans get a foothold in the economy—finding work, gaining income, and building wealth. These are unequivocally good outcomes.

But they are not enough. Simply chipping away at the mountain of inequality that has built up over the past several decades can only get us so far. Even with a historically long expansion, large differences in earnings, income, and wealth remain—especially for people of color. And these gaps are only being widened by COVID-19.

A framework for the future

So what more can we do? How can we build a society that delivers on the promise of equal opportunity and inclusive success?

First, the Fed has a critical role to play. Full employment, the idea that everyone who wants a job can get a job, is the foundation for ensuring more equitable outcomes.

To better achieve this goal, the Federal Reserve released a new strategic framework in August that lays out our approach to monetary policy for the next several years (Board of Governors 2020c).  A key component of this framework is the recognition that maximum employment is not a fixed target. It is a broad-based and inclusive goal that changes as the economy evolves.

We’ve committed to finding full employment experientially, by seeing it in wages and prices. When we’ve achieved 2% inflation on average, we will know that we have approached our maximum and that the economy is firmly on its sustainable path.

In other words, in the absence of sustained 2% inflation or emerging risks, such as to financial stability, we will not take the punch bowl away while so many remain on the economic sidelines. 

But the most critical aspect of our new framework is not about specific policies. Rather, it is about commitment. The commitment to regularly review our strategy to ensure it continues meeting the needs of the American people. 

The ingredients of this ongoing review are simple. We need to listen, research, and engage. Keep our minds open to what we hear, bring the best data and analysis to the problems we find, and have hard, action-oriented conversations around the issues holding us back from achieving our full economic potential.  

A job for all

But even with all of these actions, the Federal Reserve is only part of the solution. To achieve true equity, we need everyone. 

Our social safety net was originally crafted in the wake of the Great Depression. It collectively recognized that, at any point, any one of us might need help. That safety net and its expansions over time have become integral to the stability of the economy (McKay and Reis 2016; Christiano, Eichenbaum, and Trabandt 2016; Boushey, Nunn, and Shambaugh 2019; Lansing and Markiewicz 2018. See also the panel discussion including Janet Yellen and others at the 2020 American Economic Association Annual

Meetings). 

But a net that simply catches people when they fall is no longer sufficient. Too many people are left out from the start—without resources, without opportunity, without a fair chance. So we need a net that lifts.

How do we build this? We invest in infrastructure—opportunity infrastructure—that includes health, education, and digital connectivity. Healthy people are productive people. Education is a lifelong asset. And digital access is a public good. Investing in this critical infrastructure will help level the playing field, reduce inequality, and boost the potential output of our nation (see Daly 2020 and citations therein).

We are a rich enough country that we can afford to do this. We are a poor enough country that we can’t afford not to.

The challenge

Let me conclude with a reflection. I’ve been thinking a lot lately about the Pledge of Allegiance. I learned it in the first grade. I stood in the classroom with my hand over my heart, and I said the words, “with liberty and justice for all.”

I believed those words. I cherished those words. I wanted so very much for those words to be true.

But those words do not match the world we live in. It’s up to us to make it right. We cannot wait for the next generation of first graders.

Mary C. Daly is president and chief executive officer of the Federal Reserve Bank of San Francisco.

References

Aaronson, Stephanie, Mary C. Daly, William Wascher, and David W. Wilcox. 2019. “Okun Revisited: Who Benefits Most from a Strong Economy?” Brookings Papers on Economic Activity Conference Draft, Spring. 

Abraham, Katharine G., and Melissa S. Kearney. 2020. “Explaining the Decline in the US Employment-to-Population Ratio: A Review of the Evidence.” Journal of Economic Literature 58(3, September), pp. 585–643.

Aliprantis, Dionissi, and Daniel Carroll. 2019. “What Is Behind the Persistence of the Racial Wealth Gap?” Federal Reserve Bank of Cleveland Economic Commentary 2019-03, February 28. 

Autor, David H. 2019. “Work of the Past, Work of the Future.” AEA Papers and Proceedings 109(May), pp. 1–32.

Bengali, Leila, and Mary Daly. 2013. “U.S. Economic Mobility: The Dream and the Data.” FRBSF Economic Letter 2013-06 (March 4). 

Bhutta, Neil, et al. 2020. “Changes in U.S. Family Finances from 2016 to 2019: Evidence from the Survey of Consumer Finances.” Federal Reserve Bulletin 106(5, September). 

Board of Governors of the Federal Reserve System. 2020a. “Federal Reserve issues FOMC statement.” Press release, March 15. 

Board of Governors. 2020b. Monetary Policy Report. Washington, DC: Board of Governors, June 12. 

Board of Governors. 2020c. “Statement on Longer-Run Goals and Monetary Policy Strategy.” August 27. 

Boushey, Heather, Ryan Nunn, and Jay Shambaugh, editors. 2019. Recession Ready: Fiscal Policies to Stabilize the American Economy. Report, The Hamilton Project and Washington Center for Equitable Growth. Washington, DC: Brookings. 

Butler, Alexander W., Erik J. Mayer, and James P. Weston. 2020. “Racial Discrimination in the Auto Loan Market.” Manuscript, Southern Methodist University, June 25. Presented at the Conference on Racial Justice and Finance, Federal Reserve Bank of Atlanta, and Bendheim Center for Finance at Princeton University, September 18. 

Chetty, Raj, Nathaniel Hendren, Patrick Kline, and Emmanuel Saez. 2014. “Where Is the Land of Opportunity? The Geography of Intergenerational Mobility in the United States.” The Quarterly Journal of Economics 129(4, November), pp. 1,553–1,623.

Christiano, Lawrence J., Martin S. Eichenbaum, and Mathias Trabandt. 2016. “Unemployment and Business Cycles.” Econometrica 84(4, July), pp. 1,523–1,569.

Dabla-Norris, Era, Kalpana Kochhar, Nujin Suphaphiphat, Frantisek Ricka, and Evridiki Tsounta. 2015. “Causes and Consequences of Income Inequality: A Global Perspective.” IMF Staff Discussion Note 15/13, June. 

Daly, Mary C. 2020. “We Can’t Afford Not To.” Speech to the National Press Club Virtual Event, June 15. 

Kuhn, Moritz, Moritz Schularick, and Ulrike I. Steins. 2020. “Income and Wealth Inequality in America, 1949–2016.” Journal of Political Economy 128(9), pp. 3,469–3,519. Also Federal Reserve Bank of Minneapolis Opportunity & Inclusive Growth Institute Working Paper 9 (June 2018). 

Lansing, Kevin J., and Agnieszka Markiewicz. 2018. “Top Incomes, Rising Inequality, and Welfare.” The Economic Journal 128(February), pp. 262–297.

McKay, Alisdair, and Ricardo Reis. 2016. “The Role of Automatic Stabilizers in the U.S. Business Cycle.” Econometrica 84(1, January), pp. 141–194.

Nolan, Brian, Matteo G. Richiardi, and Luis Valenzuela. 2019. “The Drivers of Income Inequality in Rich Countries.” Journal of Economic Surveys 33(4), pp. 1,285–1,324.

Nolan, Brian, Wiemer Salverda, and Timothy M. Smeeding, editors. 2011. The Oxford Handbook of Economic Inequality. New York: Oxford University Press.

Petrosky-Nadeau, Nicolas, and Robert G. Valletta. 2019. “Unemployment: Lower for Longer?” FRBSF Economic Letter 2019-21 (August 19). 

Robertson, John. 2019. “Faster Wage Growth for the Lowest-Paid Workers.” Federal Reserve Bank of Atlanta Macroblog, December 16.

Semega, Jessica, Melissa Kollar, Emily A. Shrider, and John F. Creamer. 2020. Income and Poverty in the United States: 2019. U.S. Census Bureau, Current Population Reports P60-270. Washington, DC: U.S. Government Printing Office, September. 

Yellen, Janet L. 2006. “Economic Inequality in the United States.” Speech to the Center for the Study of Democracy, University of California, Irvine. November 6.