JACKSON HOLE PAPER : MONETARY POLICY REDISTRIBUTES WEALTH / THE WALL STREET JOURNAL

September 1, 2012, 10:00 AM
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Jackson Hole Paper: Monetary Policy Redistributes Wealth
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By Kristina Peterson

 

Central banks can help redistribute wealth after an economic shock, but must be careful in choosing when to do so, two Princeton University economics professors argue in a new paper.




Economic jolts, such as the recession following the 2008 financial crisis, can hit some sectors harder than others. For example, the banking sector can lose a large chunk of its wealth following a financial shock, write Markus Brunnermeier and Yuliy Sannikov in a paper released Saturday at the Federal Reserve Bank of Kansas City’s annual economic symposium in Jackson Hole, Wyo. In the recent recession, households also dramatically scaled back their spending to build back their savings.



In addition to their traditional role controlling short-term interest rates to influence overall economic growth, central banks can help influence how different corners of the economy recover and rebuild their wealth after a downturn, the paper argues. Cutting interest rates, for example, can reduce banks’ funding costs. Changes in interest rates can also affect asset prices, as can programs in which the central bank buys assets directly, like the Federal Reserve’s bond-buying programs. Since different groups hold different amounts and types of assets, changes in monetary policy can help specific sectors harmed by a downturn.


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“The key insight is that since economic agents differ in their asset holdings, monetary policy redistributes wealth,” the professors write. A central bank’s actions can “be seen as a social insurance scheme for an economy beset by financial frictions.”
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But the paper cautions that central banks must be careful not to create a system that gives households or companies an incentive to take on extra risks. Central banks should make sure to establish “early warning signals” about how much risk is building up in the system. Putting smart regulations in place, such as capital requirements for banks, can also help keep risk in check.


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Messrs. Brunnermeier and Sannikov also emphasize that monetary policy, financial stability and the sustainability of government debt should not be viewed as three independent concerns. A troubling situation could occur in which a government tries to pressure a central bank to allow inflation to rise to shrink the size of its debt in order to avoid having to make unpopular spending cuts, the paper warns.




That’s another reason it’s important for countries to incorporate sound monetary and fiscal policies, proper regulations that try to prevent a build-up of risk in the system and early signals that flag mounting risks before a crisis emerges, the paper states. “It is not wise to have policy rules for normal times that focus exclusively on price stability and then have additional rules for crises states.”