Saturday, April 19, 2014

Income inequality - is it demographics with monetary policy?

There is an issue with income inequality in the US. It has grown, but the real focus has to first be on why it exists. Only after quesiton has been answered can we determine how can it be solved. There has been too much rhetoric on the the fact that it has grown and that it has to be eliminated by taxing the rich.

A closer look at some of the data suggest that demographics is a key issue for explaining why it exists and has increased as well as current monetary policy. In the case of demographics, some of the problem will go away through time. With respect to monetary policy, the Fed actually choose to increase or create a strong wealth enhancement in order to generate a wealth effect on income. The result of demographics and monetary policy is going to be a greater disparity between those who already have wealth and those who do not.

The demographics at play with income inequality are significant. Following income theory, those who are middle-aged will have the highest level of wealth and income. They will then drawdown their wealth in retirement. Hence, the baby boomers as they reach or approach retirement will have a significant income advantage versus the young. As the baby boomers start to drawdown their wealth and retire, there should a closing of the income gap. The young relative to baby boomers will have a large income gap.

Similarly, marriage demographics will have a significant impact on houshold income differences. Married couples will do better than singles.This gap will increase especially if married couples are both college educated and working. The two-income college educated household will have a significant advantage over others esepcially for those who have similar professions. The income differences will also increase if there are more small businesses which may show higher income, but do not have non-incme benefits.

Income differences also leads to the economics of education. Those who have high skills in a skill-based economy are going to generate significantly more income. The income inequality of today is the result of educational policies of the past. The greater demand for skill based jobs will lead to greater income differences.

Monetary policy can have an income difference effect. The Fed stated that one of their clear goals in the post-crisis period was to increase the value of financial assets to create a wealth effect. We have seen a significant boom in equities over the last five years. The impact of the inflating of financial assets is that those who had wealth going into the crisis have more of it now. Those who did not have wealth were disadvantaged.

The hope by the Fed is that the creation of wealth will lead to a more robust economy that will translate into more income for everyone. If you take out the imapct of financial assets, income differences decline significantly. By that measure, the Fed policy of asset inflation has been a failure and has lead to greater income differences. It may not solve any problem if you generate an increase in wealth and then you tax the wealth so that it can be redistributed. 

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