Wealth Inequality, Keynesian Economics, and QE in the US

Introduction

Boushey reports in Unbound that "the very richest households — the top 1 percent — save 51 percent of their income, while those in the bottom 20 percent save just 1 percent."¹ The income gap between the top 1 percent and the 99 percent in the US has only increased since the Great Financial Crisis of 2008, when the Federal Reserve responded to the bursting housing bubble with three rounds of unconventional monetary policy. As Pew Research has shown, "economic inequality, whether measured through the gaps in income or wealth between richer and poorer households, continues to widen."²

The widening wealth inequality in America is directly related to Keynesian economics, unconventional monetary policy, and central banking intervention, which benefits the top 1 percent to the detriment of the rest of the population. This subject is important because if it goes unaddressed, the vast majority of the US population will end up as little more than serfs under the 1 percent. This paper addresses the issue of wealth inequality by examining the gap between the 1 percent and the 99 percent and explaining how Keynesian economics and quantitative easing (unconventional monetary policy) have exacerbated that gap over the decade-plus since the Great Financial Crisis of 2008.

Keynesian Economics and the Role of Monetary Policy

Classical economic theory posits that free markets are balanced by the law of supply and demand. This was the basis of Adam Smith's view that economic order and balance could be maintained so long as nations did not attempt to engage in a zero-sum game. Keynesian theory developed in response to perceived market irregularities and is based on the idea that markets will not self-correct when problems arise, because markets are inherently imperfect. During a recession, for example, wage reductions mean earners have less to spend, and savers will keep money out of the economy if the interest rate is high enough.

Keynes therefore suggested that fiscal policy (government spending) and monetary policy (control of the money supply by the central bank — the Federal Reserve in the US) should work strategically to counter business cycles and ensure balance in the economy. This idea necessitated, however, that the free market economy be transitioned into a command economy. Keynes himself "lost faith in the power of his monetary transmission mechanism, and had moved his preference towards fiscal policy," but fiscal responsibility has not been a hallmark of the US government since 2008, and monetary policy has been used to support the markets.³

The Wealth Gap and Its Structural Causes

The wealth gap in the US has widened as a result of the concentration of wealth in the hands of a few, the fact that inflation has occurred while wages have not risen enough for the working class, and that the wealthy 1 percent have amassed significant political power — which limits the potential for the rest of the population to prompt legislation that would address issues such as monopsony and monopoly by the 1 percent.⁴

For more than three decades in the post-war era, income grew at the same relative rate for all classes in the US. After the Great Financial Crisis of 2008, and the unconventional monetary policy of the Federal Reserve that led to trillions of new dollars being created and used to purchase US debt and mortgage-backed securities, the income of the top 1 percent surged while income stagnated for much of the rest of the population. That surge in the income of the top 1 percent is explained by the fact that the wealthiest individuals stood to benefit the most from central banking intervention that boosted the equities market, as they have the most investible income.

Weber's theory of social stratification helps to provide context for the post-war period of harmonious income growth. Weber posited that as economic growth occurs in a capitalistic society, the middle class grows as well. The expansion of credit after World War II helped to foster such economic growth in the US, and all classes benefited. The Bretton Woods agreement aided that expansion of credit by allowing the US dollar to serve as the reserve currency of the world, balancing out economic instabilities. The Petrodollar system prevailed in the 1970s when Nixon closed the window on the gold standard, ensuring that the USD would still be in demand, as oil would only be traded using USD under the Saudi-US Petrodollar agreement.⁵

As the US began to offshore production in the latter part of the 20th century, the middle class began to feel the effect. As Mandel has pointed out, "shifting production overseas has inflicted worse damage on the U.S. economy than the numbers show… many of the cost cuts and product innovations being made overseas by global companies and foreign suppliers aren't being counted properly. And that spells trouble because, surprisingly, the government uses the erroneous import price data directly and indirectly as part of its calculation for many other major economic statistics, including productivity, the output of the manufacturing sector, and real gross domestic product (GDP)."⁶

To counteract this trend, credit was once again made easy, and in the beginning of the 21st century, that easy credit led to the housing bubble that burst in 2007–2008. Instead of bringing production back to the US to support workers, and instead of the top 1 percent investing in American businesses for American workers and their families, they invested in equities and continued to profit from speculative trading — derivatives — that fueled the mortgage-backed securities market up until the Great Financial Crisis. Economic growth did not support the growth of the middle class as Weber had anticipated because that growth was not based upon the production of middle-class workers. America went from being a nation of production to being a nation dominated by the services industry. Production shifted to Asia, where it remains today. The middle class and its wages stagnated, while the wealth of the 1 percent continued to grow.

Conclusion

Initially after the 2008 crisis, it appeared the government had taken the right steps to stave off economic collapse. The unconventional monetary policy (quantitative easing) seemed like the right step. Businesses were saved and employment increased. However, a macroeconomic analysis reveals that Keynesian economics has led to the creation of a command economy in which the central bank is now at the heart of economic life in the US. Fiscal policy and monetary policy are now integrated to such an extent that the US Treasury Department has been run by a former Fed Chair who oversaw much of the first rounds of QE after the Great Financial Crisis. Fed Chair Powell continued QE because the labor market was still struggling to rebound from the 2020 lockdowns. The longer QE persists, and the longer rates are suppressed in accordance with Keynesian theory, the worse it becomes for the 99 percent. Inflation was not felt as acutely so long as everyone's income was growing together in the post-war years.

However, when credit tightened and jobs were offshored, the working class suddenly saw its ability to grow constrained. The allure of the American dream — everyone becoming a homeowner — led many Americans to take advantage of easy credit during the housing bubble years, but that bubble burst when credit once more tightened. Today, housing prices have risen as investors have sought to put their money into tangible assets outside of equities. The middle class is increasingly being priced out of markets. So long as production remains overseas and the 1 percent is allowed to maintain its monopoly and monopsony in the marketplace, there will be no end to the widening wealth gap in America.

Bibliography

Boushey, Heather. Unbound: How Inequality Constricts Our Economy and What We Can Do About It. Harvard University Press, 2019.

Lavoie, Marc, and Brett Fiebiger. "Unconventional monetary policies, with a focus on quantitative easing." European Journal of Economics and Economic Policies: Intervention 15, no. 2 (2018): 139–146.

Mandel, M. "The Real Cost of Offshoring." Business Week, 18 (June 2007): 29–34.

Menasce Horowitz, Juliana, Ruth Igielnik, and Rakesh Kochhar. "Trends in Income and Wealth Inequality." Pew Research, 2020. https://www.pewresearch.org/social-trends/2020/01/09/trends-in-income-and-wealth-inequality/

Spiro, D. E. The Hidden Hand of American Hegemony: Petrodollar Recycling and International Markets. Cornell University Press, 1999.

Sraders, Anne, and Lance Lambert. "Nearly 100,000 establishments that temporarily shut down due to the pandemic are now out of business." Fortune, 2020. https://fortune.com/2020/09/28/covid-buisnesses-shut-down-closed/