Monetary policy, regulation and inequality: a tale of inter-linkages
Remarks by Governor Makhlouf at Social Justice Ireland
16 November 2022 Speech
Speech at Social Justice Ireland by Gabriel Makhlouf, Governor of the Central Bank of Ireland and
Member of the Governing Council of the ECB
Good afternoon. It is a pleasure to be here today. I want to take this opportunity to talk about the Central Bank's
mission 'to maintain monetary and nancial stability while ensuring that the nancial system operates in the best
interests of consumers and the wider economy', and the importance of inequality in our considerations.
The title of my remarks today is 'Monetary policy, regulation and inequality: a tale of inter-linkages'. The use of the word
'inter-linkage' is deliberate, in two senses.
First, although I will talk a good deal about monetary policy and how it both impacts, and is impacted by, inequality, the
interaction is wider than just monetary policy.
I am thinking of our actions in the areas of macroprudential policy, as a means for building resilience to shocks; in
providing economic advice to the Government, to promote macroeconomic stability and long-term growth; and in
implementing our consumer protection framework which aims to ensure that the best interest of consumers of nancial
services are protected. These are all germane to inequality and today I will highlight some of our work in these areas in
the context of the current levels of ination that we are experiencing.
Second, what do I mean when I talk about inter-linkages? This is simply the idea that the transmission of our policies, in
terms of how they affect households, rms and the economy are affected by the level of inequality itself. This applies to
policies that aim to build resilience in the face of shocks, as well as to monetary policy changes that can impact
employment, output and asset prices. Even though inequality remains outside central banks' price stability mandate,
there is growing recognition that the distribution of income and wealth are relevant to the pass-through of monetary
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policy. And there is also evidence that monetary policy action, and non-conventional monetary policies in particular,
could be impacting on inequality
This gives you a avour of the issues I will discuss today. But rst I want to give some context, looking at recent trends in
some key inequality metrics.
Inequality trends and resilience
Since the 1980s, both income and wealth inequality - and it is important to bear these distinctions in mind - have
increased in many advanced economies. For incomes at least, Ireland is an exception as income inequality has not
increased but has actually fallen slightly since the 1980s, although the top 10% of earners still earned almost a quarter
2
of total income in 2019. In the United States, just before the pandemic, more than 45% of pre-tax income, i.e. before
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redistributive policies, went to the top 10% of earners, up from 34% in 1980.
When we think of inequality within countries, the main factors driving increases in inequality in advanced economies
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include globalisation, technological progress and taxation. Globalisation and technological progress have adversely
affected the wages and employment of lower-skilled labour, while declines in the progressiveness of the tax system in
some countries has contributed to increases in post-tax inequality. Overall therefore, the rise in income inequality has
been driven mainly by structural policies and long-term secular trends. Taking a more global perspective - that is,
across countries - global income inequality has actually decreased since the 1980s. This is mainly as a result of relatively
stronger economic growth in developing countries, when compared with developed economies.
In most countries, the distribution of the household wealth tends to be much more concentrated than the distribution of
income. For Ireland, we know this from data collected in the "Household Finance and Consumption Survey (HFCS)". This
survey on household assets, debt and wealth, has been a key part of our policy research and analysis since 2013, when
the rst survey was commissioned by Professor Patrick Honohan as Governor of the Central Bank. This survey, and
subsequent waves in 2018 and 2020, all of which have been carried by the Central Statistics Ofce (CSO) in Ireland,
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shed further light on the evolution wealth inequality in Ireland.
Building on this data, and working with other Eurosystem central banks, we recently published new Distributional
Wealth Accounts which allow for analysis of the wealth distribution of households at a higher quarterly frequency. This
data tells us that Irish household net wealth has increased signicantly in recent years, with net wealth inequality also
declining (see the infographic in Chart 1). However, ndings also point to a growing concentration of assets among
wealthier households.
Chart 1. Headline results from distributional accounts
Source: Daly (2022)
Between Q2 2013 and Q1 2022, the collective net wealth of Irish households' grew by €544 billion (Chart 2). The Top
10% of wealthy households accounted for almost half of this growth, the bottom 50% accounted for 12%, with the
remainder of the increase related to the Middle 40% of households by wealth.
Chart 2. Changes in net wealth across the distribution
Source: Daly (2022)
Notes: Wealth groupings are based on the net wealth distribution: the top 5% of the distribution (95% to 100%),
the next 5% of the distribution (90% - 95%), the following middle 40% (50% to 90%) and the bottom 50% of the
distribution (0% to 50%).
Approximately 80% of the increase in the net wealth for the Middle 40% over this period can be attributed to increases
in housing wealth (Chart 3), with the remainder a combination of growth in business wealth, deposits and other nancial
assets. Housing wealth also represents a signicant share (64%) of the increase for the Top 10%, though growing
business wealth and nancial assets are also important.
With high levels of home-ownership in Ireland (70%), it is not surprising that changes in asset values (house prices) and
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housing related debt (mortgages) play an outsized role in driving wealth inequality trends in Ireland. Indeed, the fall in
headline wealth inequality metrics since 2013 (Chart 4) can be largely attributed to the gradual decline in the proportion
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of households in negative equity since then, both via deleveraging, but also rising house prices.
Chart 3. Wealth Structure & Change Along the Net Wealth Distribution
Source: Daly (2022)
Notes: Other Financial Assets include debt securities, listed shares, investment fund shares, and life insurance and
annuity entitlements, they do not include pension entitlements or currency given low comparability between the
HFCS and QFA. Business wealth includes nancial business wealth (unlisted shares and other equity) and
nonnancial business wealth (e.g. business property and land)
Chart 4. Wealth Structure & Change Along the Net Wealth Distribution
Source: Daly (2022).
Notes: A Gini coefcient of '0' implies perfect equality (i.e. where all households have the same level of wealth),
while a Gini coefcient of '1' expresses maximum inequality (i.e. where one household holds all the wealth).
Differences in the home-ownership rate can lead to differences in wealth inequality across countries. For example,
wealth inequality as measured by the Gini coefcient tends to be lower in Ireland, when compared with the likes of
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Germany and Austria, where home ownership rates are lower.
Increasing household indebtedness is also one of the key reasons for the long-run increase in wealth inequality in Ireland
over the last three decades. As Lydon, Horan and McIndoe-Calder (2021) show, inequality rose between 1987 and
2018 due in large part to households in the middle of the wealth distribution acquiring more debt in order to purchase
housing (i.e., increasing leverage).
There are echoes here of Thomas Piketty's and others' arguments around the rise in income inequality in developed
countries, and the realted erosion of purchasing power, which in turn contributed to increased household indebtedness
for consumption in the run-up to the nancial crisis (although the increase in debt in this case is more about acquiring an
asset than maintaining consumption). Nonetheless, it is a key distributional issue for the Central Bank when we consider
the resilience of households to shocks, and in the design of our macroprudential measures to promote nancial stability.
As history has taught us, it is only often when the tide goes out that we see the vulnerabilities in relation to
distributional imbalances that have been allowed to build up.
Our borrower-based macroprudential measures - which limit the amounts households can borrow in relation to both
the value of the property and their income - are designed to strengthen the resilience of borrowers, lenders and the
economy overall. The recent review of the measures reafrmed our commitment to the tools as a means of guarding
against very high levels of indebtedness and unsustainable lending in the housing market.
As we outlined in our rst Financial Stability Review of 2022, household vulnerabilities are different to what we saw at
the onset of the nancial crisis in Ireland. Resilience is underpinned by debt levels that have fallen steadily over the last
decade, an increasing reliance on longer-term xed rates that leaves fewer borrowers exposed to rate rises in the short-
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term , as well as some households holding considerable savings built-up during the pandemic. However, as we have
highlighted in our research, these savings are likely to be unevenly distributed, with more than half of savings
concentrated in the top 30 per cent of households by income.
But we do not take this resilience for granted, especially in the face of persistent shocks. Our ongoing analysis of
household responses to high ination and income variability ( Lydon (2022), Arrigoni et al. (2022), Adhikari (2022)) as
well as to interest rate rises ( Lyons et al (2022, FSR 1, Box C)) will continue to highlight groups that are most vulnerable,
allowing for appropriately target measures to be implemented.
Next, I want to move onto price stability and monetary policy, and how this interacts with inequality.
Price stability, monetary policy and inequality
Though central banks actions can have an impact on the distribution of wealth and income over shorter horizons, over
the longer run their impact is likely to be small. As a tool that is primarily aimed at tackling cyclical uctuations,
monetary policy is unlikely to be a substantial driver of structural inequality. We know that downturns can lay bare the
different types of inequality that are lurking beneath - as I mentioned above - but, the sources of inequality run deeper
and, I believe, are more structural in nature than they are cyclical.
But this does not mean that, as monetary policy makers, we should ignore it. This was one of the key messages we heard
from the general public and representative groups when we conducted our own 'listening exercises' as part of the ECB's
2021 strategy review. To the extent that monetary policy has signicant redistributive effects, it will of course impact
inequality, at least in the short term. But an equally - if not more - important issue is how inequality can also impact
monetary policy. In other words, how pre-existing levels of inequality - either in income and/or wealth - impact how
monetary policy is transmitted to households, rms and overall economic activity.
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There has been an explosion of research on this issue in recent years. Much of it focuses on the how monetary policy
changes - for example, increasing or decreasing interest rates, or purchasing assets - affects different types of
households according to income, job-type or wealth. When I talk about 'conventional' monetary policy, if there are more
households in society whose consumption is very sensitive to income changes - typically those with limited access to
credit, or fewer savings - then the transmission of monetary policy to the real economy tends to be stronger. Our
recent Central Bank Quarterly Bulletin article on "Household Economic Resilience", emphasised this issue by
quantifying for the rst time the joint distribution of income and wealth across Irish households. We estimate that
between 6 and 15 per cent of Irish households could be considered to be in a precarious position in relation to income
risk, while also holding little - if any - in the way of savings buffers.
All of this goes to show that portfolio compositions of different households (for example, liquidity and debt) matter for
the transmission of policy, as well as when they interact with the precariousness of income. But, for macroeconomic and
monetary policy, distributional issues are not just conned to income or wealth. As I have highlighted previously on the
macroeconomic challenges from an ageing society, the distribution of age-cohorts across the population also matters. I
think of this as the demographic channel for the effectiveness of monetary policy. As we all know, populations around
the world - and especially in developed economies in Europe and the US - are ageing. If populations save more as they
age, which is generally what we see in the data, then a greater stock of savings in the future as a result of older
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populations could blunt the effectiveness of monetary policy.
The primary goal of monetary policy is to maintain price stability. This means preserving the purchasing power of the
euro by ensuring low, stable and predictable prices. The Governing Council of the ECB - consisting of the 19 (soon to be
20) national central bank governors and six members of the ECB executive board - has decided that the target of price
stability is an annual rate of ination of 2 per cent. We are clearly very far from this right now. Although nominal
interest rates have been rising, monetary policy still has a way to go to restore price stability, a pre-requisite for
sustainable growth. Interest rates have been increasing for the rst time in a decade (by 50bps in July, 75bps in
September and 75bps in October), and they are now well out of negative territory. The future direction of travel is also
clear: we expect to raise policy rates further in order to sustainably achieve our 2 per cent target over the medium term.
I realise that economic indicators point to a deterioration in the outlook for economic activity in the euro area, with
growth projections from the ECB and other institutions being revised downward for 2023 and 2024. However, this
slowdown in growth will not on its own be enough to ensure ination returns to its target of 2% in the medium term.
While maintaining price stability is our primary objective, we are also conscious of other interactions and side-effects of
our policy actions, and take them into account when formulating policy. Indeed, as we reiterated following the 2021
strategy review, we base our monetary policy decisions, which include an evaluation of the proportionality of those
decisions and their potential side effects, on an integrated assessment of all relevant factors. We will continue to do
that.
While monetary policy has important consequences for the entire economy, not every household will be affected in the
same way. The effects can also vary according to which particular policy is being implemented. And here I want to make
the distinction between changes in interest rates - sometimes labelled 'conventional' monetary policy - and changes in
the central bank balance sheet - sometimes labelled 'unconventional' monetary policy.
Conventional monetary policy - or changes in main policy rates
The direct effects of rate changes on income are relatively straightforward to understand. In the case of an increase in
interest rates, the interest paid, for instance on deposits, will rise, increasing the nancial income earned by households
with savings, who are typically wealthier households, but also many retirees. On the other hand, those who have loans,
especially on variable rates (and those on xed rates once the xation period expires), will see the repayments on their
loans increase, and as a consequence their disposable income after debt repayments will fall. This effectively results in a
transfer of income from borrowers to savers, which has implications for inequality.
Looking at the impact on wealth, when the central bank increases interest rates, asset prices typically decline reecting
the expected adverse effect of tighter monetary policy on the economy. With the rising cost of money, bond prices
decline and their yields increase; while house price growth slows as higher mortgage rates and a weaker economy
discourage more borrowing and house purchases. Typically only those at the very top of the wealth distribution are
affected by changes in stock prices, although these have an impact on retirement savings as well. Meanwhile, the impact
of movements in house prices often have an ambiguous effect on inequality, as it is households in the middle of the
income and wealth distribution that generally own their own home.
More generally, the direct effects of changes in interest rates depend on the types of assets a household owns and if they
have borrowed to accumulate them. Furthermore, the magnitude of these effects will depend on the relative and
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absolute size of each of these assets in the household's portfolio. On balance the literature tells us that, when looking
at the impact through this narrow lens, falling rates are benecial in reducing inequality, particularly income inequality in
the short-run, while raising rates can work against it.
Unconventional monetary policy - changes in the size of central bank balance sheets
Quantitative easing, which is the purchase by the central bank of sovereign and other bonds on the secondary markets,
works for the most part through its effects on asset prices (including housing) and longer-term interest rates, by
increasing the former and lowering the latter. As we know, increases in equity and bond prices tend to typically benet
wealthier households who are more likely to hold such assets. However, evidence also shows that the opposite end of
income and wealth distribution also benetted from asset purchases as a consequence of increasing employment that
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benets lower-income households in particular. Higher levels of borrowing by households and rms, led to higher
consumer spending and investment, with a positive effect on GDP and employment. This is thought to have decreased
income inequality as employment rises with aggregate demand, and lower income households benet
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disproportionately from cyclical employment expansions. For wealth inequality the literature is less conclusive. It is
difcult to quantify the effects, but they might be U-shaped, with the policy beneting households at the very top (due to
rising asset prices) as well as the very bottom (due to increasing employment) of the wealth distribution.
However, we now nd ourselves in a very different environment, and the ECB like many other central banks is
considering ways to reduce the size of its balance sheet. It might be tempting to assume that the effects of reducing the
size of the balance sheet will mirror the effects from increasing it, but there are some key differences. The primary
difference now is the context. The current high ination is having a very negative impact. Falling real incomes mean
lower consumer spending as households reduce spending on non-essentials, and divert more of their budget to items
such as food and energy. For households that spend relatively more of their budget on items that are rising fastest -
such as energy and food - the effect can be particularly acute, as we have shown in recent Central Bank research. As a
result, ination is often justiably portrayed as a regressive tax. Indeed, within an environment of stable prices, it is
easier for rms and households to plan for the future, and for Governments to invest in policies (such as health and
education) that promote wellbeing, and support the purchasing power of households, especially those on lower incomes.
By laying the foundations for a more stable macroeconomic environment, monetary policy can thus help those
policymakers that do have the power to create the conditions that improve the conditions for the most vulnerable. As I
said in my letter to the Minister for Finance in advance of Budget 2023, there is a role for scal policy in supporting
those most vulnerable to the current high rate of ination. However, supports should be temporary, tailored and
targeted, to make the most of limited resources as well as limiting the risks of adding further to inationary pressures.
The current macroeconomic environment is unprecedented as we tighten monetary policy while facing a higher
probability of a global recession. There are costs to rms and households in terms of raising rates with adverse
implications for inequality. However, these factors have to be off-set against the costs of high ination which if left
untreated in a timely and effective manner, will have far greater macroeconomic consequences. That is why we at the
ECB cannot allow ourselves to deviate from our primary objective, which is price stability.
Credibility and communication
Credibility is a key element of effective monetary policy. Credibility and good communication go hand-in-hand. As I have
outlined before, I believe transparency, honesty and engagement help to build credibility and to set expectations.
Trusting the Central Bank's commitment to price stability, and understanding exactly how it plans to go about achieving
it, inuences the public's (and nancial markets') ination expectations.
A lack of trust weakens the central bank and makes it vulnerable to political pressure. So central banks, like all
institutions, need to build social capital. There are many denitions but I like to think of social capital as "the social
connections, attitudes and norms that contribute to societal wellbeing by promoting coordination and collaboration
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between people and groups in society" . Trust is stronger where social capital is strong. Central banks can help build
social capital through their actions but also through their communications. In uncertain times, such as we are living in
today, this matters. The ECB will deliver on its mandate of price stability. Our credibility is demonstrated by our
monetary policy actions that are consistent with reaching our ination target, and by communication that reiterates our
objective and how we intend to achieve it.
Conclusion
The distribution of income and wealth is something that central banks need to pay close attention to, not least because it
has policy consequences as well as implications for social capital and the public's trust. Central banks need trust to
succeed. And trust is stronger where social capital is strong. Social capital is an important determinant of a community's
wellbeing, alongside human capital, natural capital and nancial and physical capital, what I like to describe as our
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collective economic capital.
Although central banks do not have the mandate or the tools to deal with societal concerns around income or wealth
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inequality, they can help build social capital through their actions and by continuing to focus on fundamentals.
Successful economies need stable and sustainable macroeconomic frameworks and sound monetary policy that delivers
predictable prices. They also need stable and well-regulated nancial systems and well-functioning markets. At the
Central Bank, we will continue to focus on our core mandate of price stability, a stable nancial system and the
protection of consumers. In the current ination environment, the priority for monetary policy has to be achieving our
target of 2% ination over the medium term.
Price stability is a pre-condition for economic growth and the best contribution central banks can make to ensuring
society has the resources to address the structural factors that drive inequality in society.
Price stability means we are providing the macroeconomic basis for sustainable and long-term investment in education,
health, housing, and, ultimately, being able to provide access to essential public services at reasonable cost and
supporting the welfare of the people as a whole.
See, for example, Janet L. Yellen's 2016 speech on "Macroeconomic Research After the Crisis" , which talks about the
"interactions between distribution and aggregate outcomes".
2
Roantree et al. (2021)
3
World Inequality Database (WID) (2022).
4
See for instance Wood (1998) , Gozgor and Ranjan (2017) , Lundberg and Squire (2003) , Sarte (1997)
5
The HFCS is a multi-country survey of household wealth carried out across the Eurozone. Since the rst wave in 2013,
the CSO has made several key methodological advances in the survey since it inception, putting it at the frontier of data
collection in this eld. This includes the use of multiple administrative datasets for the collection of information on
incomes, asset values and, crucially, debt. For more background on the Household Finance and Consumption Survey (or
'HFCS'), see, amongst others, Arrigoni, Boyd and McIndoe-Calder (2022), ECB (2018) and CSO (2022) .
6
Ireland's home ownership rate is around the EU average of 69.9%. However, there are some signicant differences
across the EU, for example: Germany 49.5%, France 64.7%, Italy 73.7% and Spain 75.8%.
7
See Lydon, Horan and McIndoe-Calder (2021) for an in-depth analysis of changes in the distribution of wealth since
1987.
8
See, for example, Table 6.1, page 87 in Lawless, Lydon and McIndoe-Calder (2015).
9
In just the last decade, there has been a signicant shift towards xed-rate mortgage loans in Ireland. In 2010, for
example, just 13% of outstanding loans were on a xed rate; by 2022 this had risen to around 55% of outstanding
mortgages, with 88% of new loans opting for a xed rate period.
10
See, for example, Hansen, Lin and Mano (2020) , Lenza and Slacalek (2018) , and Slacalek, Tristani and Violante (2020) .
11
In a recent paper presented at a Central Bank of Ireland seminar, Professor Joseph Kopecky from Trinity College,
Dublin highlighted very similar issues, albeit in the context of ageing populations in the likes of the US, Japan and other
European countries.
12
See Colciago and Samarina (2019) for a review
13
See Lenza and Slacalek (2018) .
14
See Casiraghi et al. (2016) .
15
Makhlouf, Gabriel. Social Capital and the Living Standards Framework . Address to University of Auckland (27 March
2018)
16
Makhlouf, Gabriel. Growing Our Economic Capital: Investing in Sustainable Improvement in Our Wellbeing . Speech
delivered at Victoria University of Wellington (3 November 2016).
Elderson, Frank. Proportioning policy action to the evidence: making the monetary policy strategy of the ECB
concrete . Address to The Institute of International & European Affairs (24 March 2022)
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