MONETARY POLICY AND THE TOP ONE PER CENT: Evidence from a century of modern economic history

Monetary policy has a significant and persistent impact on top income shares, according to new research by Mehdi El Herradi and Aurélien Leroy. Their study examines the distributional effects of monetary policy on top incomes in 12 OECD economies – Australia, Canada, Denmark, France, Germany, Italy, Japan, the Netherlands, Norway, Sweden, the UK and the United States – over a period of nearly a century from 1920 to 2016.

The global financial crisis and subsequent central bank measures raised important questions about the side effects of accommodative monetary policies. In a context already marked by rising income and wealth inequality, the distributional effects of monetary policy have become an increasingly popular topic in policy-making circles. 

This is unusual because it is widely accepted that central banks should not be concerned about inequality: they are independent of the political process, and dealing with distributional matters goes beyond their mandate. But the post-crisis monetary policy toolkit has raised several concerns about its effects on income and wealth distribution.

In fact, the combination of an ultra-low interest rate environment and large quantitative easing programmes is argued to have reduced modest household savings and driven up asset prices, which are mainly held by rich households. 

This research provides new evidence on the distributional effects of monetary policy on top incomes in 12 OECD economies over the period 1920-2016. 

First, the interest for top incomes and the top 1% in particular stem from the fact that they have largely contributed, since the 1980s, to the rising inequality in the developed world. 

Second, the historical sample has the advantage to cover important events experienced in the developed world, such as the Great Depression and the post-war boom. Such events are associated with strong monetary policy reactions, which can have in return a significant impact on income distribution.

Exogenous variations in national monetary conditions are identified using the Mundell trilemma. The latter states that a country cannot simultaneously achieve free capital mobility, a fixed exchange rate and independent monetary policy. When pursuing any two of these goals, it is necessary to abandon the third. Therefore, a country that has a fixed exchange rate and is open to capital mobility would see its interest rate variations tied to changes in the US monetary policy stance.

Such variations are considered to be exogenous because, for example, the United States during the Bretton Woods era, did not internalise the externalities of its own policy choices on partner countries.

The results suggest that monetary policy has a significant and persistent impact on top income shares. First, an unanticipated increase in the short-term interest rate reduces the top 1% income share by 0.44 percentage points over a five-year horizon for the full sample, although the effects are more than halved during the post-WWII era.

Second, the effects of monetary policy on top incomes are (i) heterogeneous and (ii) not necessarily mirrored over the entire income distribution. In fact, a positive interest rate variation reduces the shares of national income held by the top 1%, 0.1% and 0.01%, while its effect on the bottom 9% (top 10% - top 1%) of the top decile is positive.

Third, the study exploits the importance of financial assets and capital returns for top income households to demonstrate that the finding is arguably channelled via lower (real) asset returns, which is consistent with the income composition channel of Coibion et al. (2017). The results are valid regardless of the state of the economy and hold under a battery of robustness checks. 

What policy implications can we draw from these findings for the debate on monetary policy and the income distribution? Central bankers need to be attentive not only to the aggregate consequences of monetary policy but also to their side effects.


Contact details: 

Mehdi El Herradi

PhD candidate

4th year PhD fellowship at Aix-Marseille School of Economics (AMSE)