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Why the Rise of the One Percent Makes Janet Yellen’s Job Harder

  • Greater income inequality means more saving and less spending
  • Lower spending weakens growth, weighing on interest rates

Income inequality could be making Janet Yellen’s job even harder.

QuickTake Income Inequality

Rich Americans spend less of their paychecks than households of more modest means. As the top one percent accounts for an increasing share of the nation’s income, it may be reducing consumption, hurting growth and boosting savings. That could be contributing to rock-bottom interest rates that have left the Federal Reserve chair with little scope to ease in the next recession.

Take David Levine, a former chief economist at Sanford C. Bernstein & Co. who’s been a member of the one percent for decades. Levine says he’s “not living frugally” yet still spends only about a fifth of his income to maintain a very comfortable lifestyle on Manhattan’s affluent upper west side.

Contrast that with a middle-class American family. Those making between $70,000 and $80,000 spent about 78 percent of their incomes in 2014.

The debate about income inequality, and the general lack of wage growth for America’s middle class, is being amplified as a social issue by this year’s presidential race.

Now economists are taking a harder look at what it means for growth, and at a follow-on implication. By boosting savings and reducing overall demand in the economy, America’s large income divide could be one factor lowering the so-called neutral setting for interest rates, a theoretical concept that describes the interest rate that neither spurs nor slows growth.

The neutral rate matters for monetary policy makers: if it settles at a lower level, it means policy is able to provide less stimulus than in the past and officials have less room to support the economy by cutting rates the next time recession strikes. That would matter for everyone.

“There’s going to be a lot of interest in ways that we can increase that neutral rate,” said Gauti Eggertsson, a Brown University economist who is researching the topic. “If inequality is playing a role there, that might suggest fiscal policy has a role to play.”

Lower Neutral

Eggertsson and his colleague Neil Mehrotra are trying to quantify how much inequality is weighing on...


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