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The effectiveness of monetary and fiscal policy shocks on U.S. inequality: the role of uncertainty

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Abstract

The study examines the effect of monetary and fiscal policy on inequality conditioned on low and high uncertainty. We use U.S. quarterly time series data on different measures of income, labour earnings, consumption and total expenditure inequality as well as economic uncertainty. Our analysis is based on the impulse responses from the local projection methods that enable us to recover a smoothed average of the underlying impulse response functions. The results show that both contractionary monetary and fiscal policies increase inequality, and in the presence of relatively higher levels of uncertainty, the effectiveness of both policies is weakened. Thus, pointing to the need for policy-makers to be aware of the level of uncertainty while conducting economic policies in the U.S.

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Notes

  1. More details about the inequality data can be found in Coibion et al. (2017).

  2. Our results were qualitatively similar when we used categorical uncertainty dealing with monetary and fiscal policies, over 1985:1 to 2008:4, developed also by Baker et al. (2016) (available at: http://www.policyuncertainty.com/categorical_epu.html) specifically rather than overall economic uncertainty, and the monetary policy uncertainty measures developed by Husted et al. (2017) (available at: https://www.federalreserve.gov/econresdata/notes/ifdp-notes/2016/measuring-monetary-policy-uncertainty-the-federal-reserve-january-1985-january-2016-20160411.html) covering 1985:1 to 2008:4, and Istrefi and Mouabbi (2017) (available at: https://sites.google.com/site/istrefiklodiana/interest-rate-uncertainty or https://sites.google.com/site/sarahmouabbi/interest-rate-uncertainty) over the period of 1993:2 to 2008:4. Since, these indices are available monthly, we used temporal aggregation to convert to quarterly frequency. Complete details of these results are available upon request from the authors.

  3. The newspapers searched are: the Wall Street Journal, the New York Times, the Washington Post, the Chicago Tribune, the LA Times, and the Boston Globe, along with USA Today, the Miami Herald, the Dallas Morning Tribune, and the San Francisco Chronicle.

  4. The fiscal and monetary policy shocks were obtained from: http://econweb.ucsd.edu/~vramey/research.html#govt and http://lorenzkueng.droppages.com/, respectively.

  5. We tried to compare conventional and unconventional monetary policy impacts on inequality. To do this, we regress unconventional monetary policy proxied by the U.S. shadow short rates on inequality (Gini coefficient) using recursive estimation. The shadow short rates data were obtained from https://sites.google.com/site/jingcynthiawu/home/wu-xia-shadow-rates (Wu and Xia 2016) while the Gini coefficient data were sourced from https://www.shsu.edu/eco_mwi/inequality.html (Frank 2009, 2014). We converted the monthly shadow short rates data to annual data since the Gini coefficient data are available on annual basis from 1917 to 2015. The plot of the slope coefficient (C2) from 2008 to 2015 shows that monetary policy still has a positive relationship with inequality. Hence the results are robust to both conventional or unconventional monetary policy. Results are available from authors upon request.

  6. We also interacted the fiscal policy shock with the news-based measure of partisan conflict developed by Azzimonti (2018) (available at: https://www.philadelphiafed.org/research-and-data/real-time-center/partisan-conflict-index). The Partisan Conflict Index tracks the degree of political disagreement among U.S. politicians at the federal level by measuring the frequency of newspaper articles reporting disagreement in a given month. Higher index values indicate greater conflict among political parties, Congress, and the President. We used temporal aggregation to convert the monthly data to quarterly frequency. Interestingly, we observed, over 1918:01 to 2008:4, that the strength of the tax shock is stronger under higher degrees of partisan conflict than lower levels of the same. This could possibly be due to the fact that partisan conflict and uncertainty are negatively correlated, since with higher partisan conflict agents might believe that policies are less likely to change, and hence, there is lower level of policy uncertainty, as discussed comprehensively in Azzimonti (2018). Complete details of these results are available upon request from the authors.

  7. Also we conducted the analysis using the 10th and 90th percentiles as well as the 25th and 75th percentiles definition of low and high uncertainty. In general, the effects are lower under high uncertainty. Results are available upon request from the authors.

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Authors and Affiliations

  1. Department of Economics, University of Pretoria, Pretoria, 0002, South Africa

    Goodness C. Aye, Matthew W. Clance & Rangan Gupta

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  1. Goodness C. Aye
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  2. Matthew W. Clance
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Correspondence to Goodness C. Aye.

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We would like to thank three anonymous referees for many helpful comments. However, any remaining errors are solely ours.

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Aye, G.C., Clance, M.W. & Gupta, R. The effectiveness of monetary and fiscal policy shocks on U.S. inequality: the role of uncertainty. Qual Quant 53, 283–295 (2019). https://doi.org/10.1007/s11135-018-0752-3

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