Rate rises threaten to reverse America’s post-Covid equality gains

When Jay Powell, US Federal Reserve chair, announced another big interest rate hike on Wednesday, he grimly admitted the obvious: “Reducing inflation is likely to require a sustained period of below-trend growth and there will very likely be some softening of labour market conditions.” 

The Federal Open Market Committee now projects that the overall unemployment rate will hit 4.4 per cent next year, up from earlier forecasts of 3.9 per cent, and the current level of 3.7 per cent.

That is bad news for a White House that faces a tough midterm election in the teeth of voter fury about cost of living increases. But the issue that is perhaps even more pressing for politicians, as well as Fed economists, is exactly how this pain might be distributed between different income groups.

In the past few years Powell has often defended the Fed’s loose policy, arguing that by ensuring a red hot economy the Fed was also creating jobs that lifted people out of poverty. So will this dynamic now be reversed as rates rise? In other words, could the Fed decision be regressive?

Judging from some striking new research released this week, just before the Fed move, the unwelcome answer is: “probably yes.” 

This analysis comes from the economists Emmanuel Saez, Thomas Blanchet and Gabriel Zucman. Their starting point is the observation that it has hitherto been very difficult to assess in a timely manner how inequality trends are shaping economic growth.

The US government publishes aggregate statistics about earnings, spending and growth with a lag of just a few weeks. But granular information about trends in different socio-economic groups only emerges after a long delay — and from different sources. Previously, when economists such as Thomas Piketty (or indeed Saez himself) have warned about widening inequality in America, they have done so by constructing historical data series rather than examining current trends.

This time, however, Saez’s group has tried to plug that information gap by creating so-called high frequency inequality data. This means aggregating a vast array of public and private information sources, including non-traditional ones, to create monthly calculations of how income and wealth patterns are evolving, almost in real time.

This ambitious undertaking is still a work in progress, and the methodology has been made open source, to enable widespread testing. But the initial data series, which goes back to 1976, contains two very thought-provoking messages for America’s current political economy.

The first is that the recession induced by the Covid-19 pandemic had a different impact on US households than that of the global financial crisis. The post-crisis recession sparked a slump in Americans’ incomes, and it took four long years for economic activity, measured by average gross domestic product per capita, to recover to pre-crisis levels.

That post-crisis period was even worse for the poor. According to Saez, Blanchet and Zucman, it took “nearly 10 years for the bottom 50 per cent [of workers] to recover [their] pre-crisis pre-tax income level”. This is almost certainly one of the factors that fuelled the rising tide of populism in recent years.

However, when the Covid recession hit in the spring of 2020, initially causing another sharp decline in incomes, there was a swift recovery. “All income groups recovered their pre-crisis factor income level within 20 months”, they observe. Indeed, by 2021, average real disposable income was a remarkable 10 per cent above 2019 levels.

And what is even more striking is that on this occasion the poorest cohorts were not excluded from the gains, On the contrary, average disposable income for the bottom 50 per cent was actually 20 per cent higher in 2021 than in 2019.

This leads to a second key point: while the Covid recovery slightly reduced income inequality, this was not universal. Racial inequalities remained stark, and inequities of wealth, as opposed to earnings, swelled because the Fed’s ultra loose monetary policy bolstered the price of assets held by the rich.

But if you just look at real household incomes — arguably the measure that most voters are aware of on a day-to-day basis — the pattern produced relative gains for the poor. And that was a “break from the trend [of rising inequality] prevailing since the early 1980s”. 

Why? Initially, the rebound stemmed from one-off Covid welfare payments. However, the bigger, and more durable, factor was strong job and wage growth among low-paid workers. And in 2022, this tight job market has continued to benefit the poor — even as welfare payments have ended — with their incomes 10 per higher than they were pre-pandemic.

So will this trend now go into reverse? It has not done — yet. But some progressive politicians, such as the Democratic senator Elizabeth Warren, are clearly worried as rates keep climbing, particularly given that high inflation tends to hit poor people harder in relative terms. “What [Powell] calls ‘some pain’ means putting people out of work, shutting down small businesses,” she observed last month, railing angrily against the Fed.

And as the midterms loom, such attacks could multiply. All eyes, then, on Powell’s next move, and how this looming “pain” affects voter sentiment.

gillian.tett@ft.com