UC Davis

I explore the dynamic effects of monetary policy on the distribution of household wealthin the United States. I provide new evidence that monetary policy plays a significant role in driving persistent movements in wealth inequality. Using the new Distributional Financial Accounts and high-frequency identification, I find that contractionary monetary policy disproportionately reduces the net worth of the bottom 50% of households by wealth. By decomposing net worth into asset prices and quantities, I find that wealth dynamics for the top 1% of households follow from a reduction in equity prices while the dynamics for the bottom 50% of households are driven by high leverage ratios and a reduction in holdings of and consumer durables, consistent with a consumption smoothing motive. I show that the magnitude of these responses is larger following episodes of monetary tightening than easing for the bottom 50%. Additionally, we study how the level of government debt affects the effectiveness of monetary policy, i.e., the elasticity of economic aggregates to interest rate changes. We build a New Keynesian model where fiscal policy is non-Ricardian and government debt is risk-free. Wealth effects generated by government bonds weaken the transmission of changes in the policy rate to output. Using data on private ownership of public debt for the U.S., we find that when government debt is one standard deviation above its mean, the response of industrial production and unemployment to an expansionary monetary shock is reduced by 0.5pp and 0.075pp, respectively, out to a three-year horizon. Finally, I study the dynamics of the household wealth distribution in response to changes in government spending in the U.S. I find that increases in government spending raise the net worth of all groups except for the top 1%. Decomposing the responses of wealth into broad asset and liability classes, I find that responses are largely driven by an appreciation in the price of real estate. These results are consistent with a mild and temporary compression of the household wealth distribution.