Ultra-easy monetary policy: redistributive effects

The ultra-easy monetary policy holding sway on both sides of the Atlantic has led to extensive debate on the redistributive effects of keeping interest rates at very low levels for a prolonged period of time. Not all households are affected in the same way: some, generally those most in debt which are also usually the youngest, benefit from low interest rates while others, the savers, are hit hard as they get fewer returns from the interest on their savings.

As a whole, euro area households are net savers. In other words, their financial assets are greater than their financial liabilities, which means that drops in interest rates tend to reduce their disposable income. However, the costs and benefits are not distributed evenly among different households. Lower-income households tend to have a higher debt-to-income ratio. For example, in the euro area, this ratio stands at 351% for the 20% of households with the lowest income, whereas for the average household it is 167% and for the 20% of households with the highest incomes it falls to 103%. It therefore comes as no surprise that those who benefit the most from drops in interest rates are lower-income households. Specifically, a drop of 1 pp in the interest rate on debt reduces the annual financial burden of lower income households by 360 euros (3.5% of their income) while for higher-income households this reduction is 1,750 euros (1% of their income).

An analysis by country is similar: those with the highest levels of debt, such as the Netherlands and Spain, are benefitting the most from lower interest rates. In the Netherlands, for example, 68% of households are in debt and they have, on average, a debt-to-income ratio of 266%. In this case, a drop of 1 pp in the interest rate reduces their financial burden by 944 euros (1.8% of their income). In Italy, however, only 23% of households are in debt and they have a debt-to-income ratio of 118%. In this case the financial burden falls by just 92 euros (0.3% of their annual income).

Changes in interest rates also affect financial revenue. 96.4% of European households have a bank deposit although the size of the return is small compared with the household's total income. For example, on average European households hold 28,623 euros in deposits. A drop of 100 bps in the interest rate on deposits leads to a loss of 286 euros per year, representing 0.6% of an average household's income. The effect is greater for lower-income households as, in spite of having fewer deposits, these account for a greater proportion of their income. Specifically, in this case the reduction in returns would be 93 euros, 0.9% of their annual income.

In short, low interest rates benefit those households and countries most in debt, which means that expansionary monetary policy is helping deleveraging in those households with the greatest difficulty in paying off their debts. Another more difficult issue to determine is how these policies affect household wealth: the low interest rates and the injection of liquidity carried out by the main central banks are pushing up the value of financial and property assets. For example, part of the significant gains in the stock and bond markets could be a result of these policies. In this respect, those households with more assets will benefit the most. However, the empirical evidence available does not allow us to determine which part of these gains in assets is due to ultra-easy monetary policy and which part of such gains is permanent.(1)

(1) See «QE and ultra-low interest rates: distributional effects and risks», McKinsey Global Institute Discussion Paper, November 2013.