Karen Petrou Says Higher Rates ‘Should Be Resolutely Pursued’


Banking consultant Karen Petrou is right that Federal Reserve policies have helped the rich. It’s not so clear, though, that reversing those policies would help the poor.

The Fed’s marble headquarters appears under a foreboding sky on the cover of Petrou’s book, Engine of Inequality: The Fed and the Future of Wealth in America. She repeatedly argues that the Fed has worsened inequality by pushing down interest rates. Here’s an early passage:

As the Federal Reserve sucked trillions of safe assets from the financial system [by buying Treasuries and mortgage bonds], investors looked desperately for places to put their funds. Starved of Treasury obligations and even of the chance to earn a reasonable rate of return by putting money in the bank, investors had little choice but to head to the stock market or to high-risk assets promising returns above the Fed’s low rates. … If all Americans owned stock, then all Americans would benefit from rising markets, but all Americans don’t own stock; the bulk of household stock ownership—86.5 percent—was in the hands of the wealthiest 10 percent of households, and the top 1 percent owns more than half of all U.S. stock.

All that is correct, and Petrou, the co-founder and managing partner of the consulting firm Federal Financial Analytics, is right to focus on it as a problem. But the cure isn’t to raise interest rates. Yet that’s what she comes around to advising in the book’s final pages.

Instead of driving rates ever lower in an ineffectual search for economic recovery, the Fed must gradually raise rates to levels that ensure a positive real return—that is, make money in the bank turn into money for the future. As we have seen, US interest rates long hovered around 5 percent—now, a determined increase first to 1 and then to 2 and then to 3 percent or more should be resolutely pursued.

The word “resolutely” in that last sentence is revealing, because it’s used for soldiers heading into battle. A bloody battle it would be if the Fed began jacking up interest rates now, with unemployment still high and the economy still shadowed by Covid-19. The stock market would plunge, of course. Even if you don’t care about stock investors because you’re trying to solve inequality, you can’t avoid the fact that they would pull back on their spending, which would chill economic growth and throw less prosperous Americans out of work. A stock plunge would also cause businesses to invest less in new plant and equipment—again hurting ordinary workers.

Petrou is correct that the poor and the lower middle class don’t own stock, but the idea that they’re being punished by low interest rates is a bit strong. People who don’t own stock also tend not to have a lot of money in the bank, so they aren’t significantly hurt by very low interest on savings accounts and certificates of deposit. Their problem is not having the wrong kind of assets, it’s not having any assets at all. Meanwhile, they’re helped by low rates on car loans and leases and other consumer credit. 

The loudest cries of pain over the Fed’s ultralow interest rates are coming not from the poor but from ultrarich hedge fund managers, who find it hard to beat the market when prices of doggy stocks and dodgy bonds are going through the roof. And here’s something that investors tend to miss: Trees don’t grow to the sky and rallies don’t last forever. When stock and bond prices are historically high, as they are now, future returns are likely to be low, if not negative. What looks like a gift from the Fed to wealthy Americans won’t look so wonderful when financial assets level off or even fall in coming years.

Petrou is right that we’re past the point of diminishing returns from aggressive monetary policy. The Fed can’t fix the economy by itself. But the Fed itself has been the first to say that. Fed chiefs Ben Bernanke, Janet Yellen, and now Jerome Powell have called on Congress to do what only it can, namely stimulate growth by spending more and, in some cases, taxing less. Since the pandemic began, Congress has been doing exactly that, relieving pressure on the Fed to be the only game in town.

Inequality is a serious problem. Raising interest rates right now is not the way to solve it.

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