Thursday, March 29, 2007

Income Inequality, Monetary Policy & The Left

The New York Times reports that income inequality in America rose sharply in 2005, to its highest level since 1928. This was also noted by the leftist Economic Policy Institute.

What is missed is why inequality has increased. Leftists typically blame foreign trade and Bush's tax cuts, while paleoconservatives , in addition to trade, often blame immigration. Yet while there may be some limited truth in these explanations, the perhaps most important explanation is left out. What explanation, you might wonder. Well, ask yourself, what was special about 1928? The answer is that it was the peak of a stock market bubble and strong cyclical boom. Income inequality then fell sharply during the great depression. Similarly, income inequality previously peaked in 1999, at the height of the tech stock bubble, and then fell back in 2001-2003.Only to rise again in 2004-2005. See the pattern here? Income inequality rises during booms and falls during busts, as the prices of assets mainly held by the wealthy rise druing booms and falls during busts.

This is the way it has always been, and it is predictable from a theoretical perspective. Because newly created money tends to affect asset prices before product prices and product prices before wages, monetary driven booms will tend to increase relative income for the wealthy and reduce it for the poor.

So if the left really thinks rising income inequality is so bad, why don't they fight for hard money? In reality, Economic Policy Institute and other leftists typically supports inflationary monetary policy, see for example here.
The idiots at EPI in fact seems to be under the illusion that inflationary monetary policies will reduce income inequality, when basic economic theory and all historic evidence shows that it will increase it.


Blogger Libertyfirst said...

Interesting post, as usual. But what's your opinione about Fig.2 in the EPI link? It shows that since 1979 wages have remained constant and productivity has increased: this is a 25-30 years trend. Is it a statistical illusion? Or is it the effect of capital consumption in the US, imports from China and/or immigration from Latin America? If it had happened after Greenspan era, I would have said that growth has been inflationary and not real. But 1979... may be it is the long run of Nixon's monetary reforms. In front of that figure I would have problem discarding the bargaining power theory, which is theoretically unsound, but apparently supported by some "Reagan enemy of the working class" rethoric.

12:01 PM  
Blogger stefankarlsson said...

Well, to a large extent it is a statistical illusion. When I checked at the Bureau of Labor Statistics web site, real hourly compensation of labor in the business sector had increased by more than 35% since 1980 (and government pay have increased even more). While that may to some extent reflect higher pay for CEO:s , movie stars and Wall Street brokers, the discrepancy is to large for the EPI:s numbers to be true. And while corporate profits are indeed at record highs, they aren't anywhere near as big as EPI:s figure implies.

I am not sure exactly what number the EPI refers to, but presumably they must refer to some number that excludes non-wage benefits, which has increased a lot faster than wages. Moreover, wages are deflated by the CPI, while productivity is deflated by business output prices which have increased a lot slower than the CPI. So the EPI is comparing apples to pears, so to speak.

Now, while the EPI figure for above mentioned reasons greatly exaggerate just how big the shift in income from labor to capital have been, I think for example Alan Reynolds is wrong to try to deny it alltogether. Part of it is real and that part is in turn a combination of structural and cyclical factors. Structural being a weaker bargaining position for many workers due to increased competition from imports and immigration and cyclical being the increase in corporate profits relative to labor income that we always see during booms.

6:07 PM  
Blogger Libertyfirst said...


10:49 PM  

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