Federal Reserve: Rate hike decreases inequality

The US Federal Reserve has a new way to justify interest rate increases to contain inflation: It presents them as the best way to combat economic inequality.

This attitude contrasts with their traditional perspective regarding interest rates. Until now, sharp increases in interest rates like those announced for the coming months were considered harmful for low-income people. That sector is the one that suffers the most if the increase in rates generates an economic slowdown, unemployment and even a recession.

But now, some of the “Fed” officials who most favor low rates to protect the labor market say that inflation is cruel to the poorest and that containing inflation is a matter of justice. The burden of high prices “is particularly heavy on poorer households,” said Lael Brainard, an influential member of the Fed’s Board of Governors and a longtime advocate of low rates. “Containing inflation is our most important task right now,” she said in a speech Tuesday.

Brainard noted that food and energy account for a quarter of the price increases causing the highest inflation in the United States in 40 years. The poorest sectors spend a quarter of their income on food and transportation, he said, while the wealthiest classes spend less than a tenth.

Lawmakers from both parties agree that it is vital to contain inflation by gradually raising interest rates, a measure that will raise the cost of lending to individuals and businesses. In fact, most economists believe the Fed took too long to take this step and now risks having to curb credit too quickly, derailing the economy. Last month, the Fed raised its key rate from near zero to between 0.25% and 0.5%.

Some Democrats fear that a rise in interest rates will depress hiring at a time when unemployment is higher among African-Americans than whites.

“Clearly there is a lot to be done to make sure everyone has access to quality jobs,” Democratic Senator Sherrod Brown said last month at a hearing on Jerome Powell’s nomination for a second term as Fed chairman. “Raising interest rates too early can hurt labor market growth.”

Tim Duy, the chief economist at SGH Macro Advisers, and other analysts say the Fed is right to highlight the damage inflation can do to the poor. But it also suggests that the Fed is stretching it a bit when it says that inflation exacerbates economic inequality.

Citi’s Nathan Sheets, who worked at the Fed, says inflation reduces the burden of debt, an element that can disproportionately affect low-income people. Salaries often rise in line with inflation. But mortgages and other debt generally have fixed interest rates that are easier to pay if your income rises due to inflation.

Brainard’s speech this week was one of the most notable examples of the Fed’s new thesis that inflation exacerbates inequality. Brainard said that the lowest-income households — one-fifth of the population — spend 77% of their income on basic needs, such as food and shelter. In contrast, those with higher incomes cover their basic expenses with 31% of their income.

Mary Daly, president of the Federal Reserve Bank of San Francisco and a longtime believer in the philosophy of keeping interest rates low, shocked many this week by declaring that “inflation is as bad as not having a job.”

Not being able to pay your bills or not being able to save for what you want “is something that keeps you up at night,” Daly told the Native American Financial Officers Association.

Powell himself began to change his perspective last year, when, testifying before Congress, he spoke of the high impact of inflation on the poorest, according to Duy.

It was a remarkable turnaround for Powell, who has focused on inequality far more forcefully than his predecessors.

The Fed hinted that it would take into account the unemployment rates of African-Americans and Hispanics when setting its interest rates. The US central bank also indicated that it would not raise rates in anticipation of an increase in inflation, but would wait for that increase to materialize.

Brainard said in February 2021 that getting ahead of inflation “can affect the progress of racial and ethnic groups, which have faced systemic problems.”

Powell and other Fed officials say their current goal is to lower inflation by reducing, not slowing, growth. They say that reducing inflation is important for the economy to continue expanding and unemployment to remain low.

Sheets thinks the Fed can raise rates without worrying too much about the labor market as their benchmark rate is so low right now. The Fed considers that its reference rate will not affect growth until it reaches 2.4%.

Minutes from the Fed’s most recent meeting, in March, released on Wednesday reveal that the central bank wants to reach that level as quickly as possible. Economists calculate that it would by the end of the year.

At that point, if inflation remains too high, the Fed could raise rates again, until a certain level of unemployment is generated and the specter of a recession looms.

“That’s where things get complicated,” Sheets said.

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