Can low inflation and financial stability reduce inequality?

Martin Wolf of the Financial Times wrote a piece on ‘Monetary Policy is not the solution to inequality’. In it he mentioned that as well as the traditional means of taxation and government welfare spending, can central banks also assist with reducing the level of inequality in an economy? In maintaining aggregate demand (C+I+G+(X-M)) and stimulating economic growth there runs the risk of higher prices and a business cycle that becomes a volatile series of booms and busts – see previous post.

With the housing sector coming under close scrutiny by central banks higher interest rates to reduce house prices would also impact AD and raise unemployment. With some lower income groups living from pay check to pay check this would make matters worse. The graph below shows the impact of taxation and welfare spending has on inequality levels – note China and India. You can see those economies that have a more left wing government policy objective.

Source: FT – Monetary Policy is not the solution to inequality.

Rising inequality had led government’s to choose between higher unemployment or increasing levels of debt by expansionary monetary policy from the central bank. Either you allow people to borrow excessive amounts of money to boost AD or the economy slows and unemployment rises. A better solution could be to reduce the incentive to fund housing etc by the accumulation of debt but with equity financing

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