PGIM Fixed Income Weekly View from the Desk
Gauging Central Banks’ Reaction Functions
The Biden Administration is taking direct aim at economic inequality in the United States. In recent decades, such inequality has only become more severe. As just one metric—since 1990 the wealth share of the Top 1% of households has risen from 23% to 31%. In parallel, the share of the Bottom 90% has sunk from 40% to just 31%. Thus, the Top 1% holds as much wealth as the lower 90% combined. Janet Yellen has made clear that she will work to better balance the economic scales during her time as Treasury Secretary.
In this spirit, we first examine some features of U.S. wealth inequality. We then consider the contribution of one key factor—a rising equity market—to the observed widening in the wealth gap. We conclude by suggesting a few implications for policymakers and investors.
Figure 1 offers a breath-taking snapshot of the disparity in wealth. At present, an average household in the Top 1% has assets totaling over $28 million. These holdings are particularly concentrated in public equities ($12.3 million) and ownership of small businesses ($5.4 million), but include sizable holdings of other asset types as well.
In contrast, the average household in the Bottom 50% has just $37,000 of wealth, composed mainly of real estate and pension entitlements. Further, these households have consumer debt that exceeds the value of their durables, which shows up as a negative entry in the “Net Other” column of the table. Bottom line—the average household in the Top 1% holds over 750 times more wealth than a household in the Bottom 50%.
The holdings of the Middle 40% (the 50-90 percentiles) come in at $651,000. The big difference between this group and the Bottom 50% is that they have meaningful pension and real estate holdings. The Next 9% (the 90-99 percentiles) have $3.9 million of wealth on average, including over $1 million of pension entitlements and nearly as much in public equities.1
We now look in more detail at the contributions of the rising equity market to these divergent outcomes. As shown in Figure 2, our estimates indicate that households in the Top 1% and Next 9% have accrued the vast majority of equity holding gains. These two cohorts have enjoyed $22 trillion of gains since 1990, versus roughly $4 trillion of gains for those in the Bottom 90%.2 All told, they hold nearly 90% of all household equity wealth.
The next set of figures examines the broader implications of these data. How much has the extraordinary rise in the equity market over the past thirty years contributed to the observed divergence in wealth distribution?
Figure 3 calculates counterfactual wealth shares, assuming that the equity market remained flat at its 1990 level, rather than appreciating by more than 10 times. Under these assumptions, the share of the Top 1% would have gone up by just 2 percentage points, rather than by 8 percentage points. The wealth of this top cohort is concentrated in equities and, as such, they have benefited handsomely from the rising market.
In contrast, the exclusion of equity gains has little effect on the wealth share of the Next 9%. The stock market’s climb has meant that this group has lost ground relative to the equity-intensive Top 1%, but they have gained versus everyone else.
The most striking results, however, are for the Middle 40%. With a flat equity market, this group would have seen its share fall by just 3 percentage points, rather than the 8 percentage points actually recorded. They have benefited much less from the rising equity market than the top two cohorts. Indeed, the rising market has been a key driver of their declining wealth share.
Tragically, the inclusion or exclusion of equity gains has little bearing on the fortunes of the Bottom 50%. These folks hold very little wealth of any kind. Hence, the analysis yields the same result—their wealth share is minimal—whether the stock market is high or low or if, in the extreme, stock holdings are disregarded altogether.
Of course, in an absolute sense, the rising stock market has made essentially everyone better off. But our point is that the gains over the past several decades have been unevenly distributed. The rising equity market has lifted all boats, but some have benefited significantly more than others.
The challenge is determining what these observations imply for future economic policy. If a rising stock market generates increased inequality, the solution can’t be to push the stock market down. But what should be done? How can we ensure that U.S. economic gains are shared more widely across the population?
As one set of possibilities, recall that the factors differentiating the Middle 40% from the Bottom 50% are their meaningful holdings of pension claims and real estate. These assets have been effective “up elevators” in allowing broad swathes of the population to accumulate wealth. The challenge is to further expand access to real estate ownership and participation in pension programs. For the former, this shouldn’t mean putting families in houses that they can’t afford. But it might mean offering some households mortgage rates subsidized by the government or, even more critically, assistance with down payments. For pensions, it could entail outright federal subsidies for pension contributions—lower income workers might be eligible for 2 or 3 dollars of match for each dollar that they contribute to a pension plan. Moderate increases in income taxes for high-end earners and the estate tax could help finance and complement these initiatives.
If such efforts fail, more aggressive prescriptions, including wealth taxes, could surface. These approaches would undoubtedly gain traction in reducing wealth inequality, but they also might risk impeding the economy’s wealth generating capacity.
This material reflects the views of the author(s) as of February 11, 2021 and is provided for informational or educational purposes only. Source(s) of data (unless otherwise noted): PGIM Fixed Income.
1For a more detailed discussion of these issues, please see our earlier paper, “Wealth Inequality—A Tale of Diverging Tails,” September 2019.
2For each year, the flow of funds data decompose the aggregate increase in equity holdings into the portion associated with “holding gains” due to rising share prices and the portion from “net acquisitions.” Drawing on the Fed’s Distributional Financial Accounts, we assume that the holding gains are distributed across wealth cohorts in proportion to their holdings of equities, i.e., that returns across cohorts are similar. To the extent that wealthier cohorts notched higher returns, their holding gains will be understated by our estimates.
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