Engine of Inequality

The first book to reveal how the Federal Reserve holds the key to making us more economically equal, written by an author with unparalleled expertise in the real world of financial policy

Following the 2008 financial crisis, the Federal Reserve’s monetary policy placed much greater focus on stabilizing the market than on helping struggling Americans. As a result, the richest Americans got a lot richer while the middle class shrank and economic and wealth inequality skyrocketed. In Engine of Inequality, Karen Petrou offers pragmatic solutions for creating more inclusive monetary policy and equality-enhancing financial regulation as quickly and painlessly as possible.

Karen Petrou is a leading financial-policy analyst and consultant with unrivaled knowledge of what drives the decisions of federal officials and how big banks respond to financial policy in the real world. Instead of proposing legislation that would never pass Congress, the author provides an insider's look at politically plausible, high-impact financial policy fixes that will radically shift the equality balance. Offering an innovative, powerful, and highly practical solution for immediately turning around the enormous nationwide problem of economic inequality, this groundbreaking book:

• Presents practical ways America can and should tackle economic inequality with fast-acting results
• Provides revealing examples of exactly how bad economic inequality in America has become no matter how hard we all work
• Demonstrates that increasing inequality is disastrous for long-term economic growth, political action, and even personal happiness
• Explains why your bank's interest rates are still only a fraction of what they were even though the rich are getting richer than ever, faster than ever
• Reveals the dangers of FinTech and BigTech companies taking over banking
• Shows how Facebook wants to control even the dollars in your wallet
• Discusses who shares the blame for our economic inequality, including the Fed, regulators, Congress, and even economists

Engine of Inequality: The Fed and the Future of Wealth in America should be required reading for leaders, policymakers, regulators, media professionals, and all Americans wanting to ensure that the nation’s financial policy will be a force for promoting economic equality.

Acknowledgments xi

About the Author xiii

Introduction xv

Chapter 1 Inequality: Why It’s So Much Worse and What to Do About It 1

What We Know about Inequality that Economists Don’t 4

The Economic-Recovery Mirage 5

Why So Unequal So Fast? 7

Regulatory Wreckage 12

How to Fix Financial Policy 14

Chapter 2 How Unequal Are We? 18

Economic Inequality Fundamentals 19

Who Has How Much 22

What of Wealth? 24

The Inequality Engine 24

Worse Than That 25

The Most Inclusive Ever? 27

The Great Financial Crisis and Its Equality Aftermath 29

Chapter 3 What Makes Us So Unequal 32

The Mechanical Engineering of Economic Inequality 34

Death and Taxes 35

The Role of Transfer Payments 37

A Supply-Side Solution? 38

Public Wealth: A Sputtering Part in the Equality Engine 39

Is Education the Answer? 41

Is Trade Policy a Problem? 42

Global Policy Reform? 43

What to Do? 45

Chapter 4 Why Does Economic Inequality Matter So Much? 46

Inequality and Mortality 47

Political Polarization 49

Inequality’s Eviscerating Cost 50

Inequality and the Long Recession 52

Financial-Crisis Risk 53

Chapter 5 Following the Money 55

How Central Banks Work 57

The Modern Monetary-Policy Construct 60

The Fed’s Bailout Buckets 62

The Fed’s Payment Powers 64

Rules of the Financial Road 65

Four Fundamental Financial-Policy Flaws 69

Chapter 6 How Monetary Policy Made Most of Us Poorer 73

The Fed’s Heavy Hand 76

Why It’s the Fed’s Fault 77

How Ultra-Low Interest Rates Made America Still Less Equal and QE Still More Inequitable 80

The High Cost of Low-Rate Debt 83

The Low-Unemployment Myth 85

The Anti-Wealth Effect 87

Making Matters Still Worse 91

A Bigger Fed, Lower Rates, an Extreme Financial Crisis 93

Chapter 7 How to Make Monetary Policy Make Us More Equal 95

The Aggregate-Data Error 98

The Fed’s Real Mandate 102

The Fourth Mandate 104

The Fed’s Giant Faucet 105

Possible Solutions 108

Slowing the Inequality Engine 111

Chapter 8 Reckoning with Regulation 113

Consumer Finance Before the Crash 115

Are Debtors Just Deadbeats? 117

Are Banks to Blame? 118

The Businesses Banks Left Behind 120

Other Precursors of the Crash That Came 121

Capitalism and Capital Regulation 123

A Capital Cure 127

Going with the Flow 128

Death without Destruction 130

The Consumer-Protection Quagmire 131

An Unreadable Rulebook Thrown Only at Banks 133

The Bleak Outlook and a Better Future 134

Chapter 9 Remaking Money 137

What Money Is and Will Be 139

The Great Unequalizer 141

Turning Money into Data 143

What Makes Money Good Money 145

Crafting a Good Digital Dollar 146

How Money Moves 148

The Central-Bank Solution 151

Chapter 10 Rules to Equitably Live By 153

Why Not Just Deregulate? 156

Learning to Love Like-Kind Rules 158

The Specifics of Symmetric Regulation 161

Raising Up the Regulatory Playing Field 162

Building a New, Equality-Focused Banking System 165

Banking While Mailing 166

Establishing Equality Banks 168

New Money for a New Mission 170

Chapter 11 Financial Policy for an Equitable Future 175

Turning the Fed into a Force for Good 176

The Fed’s Failings 178

The Fed’s Equality Toolkit 178

The First Fix: Understanding America as It Is 180

The Second Fix: Set an Equality Plan and Say So 181

The Third Fix: A Far Smaller Fed Portfolio 183

The Fourth Fix: Normal, Moderate Interest Rates 187

The Final Fix: Ensuring Financial Stability 188

Ending the Doom Loop 190

The Future of Equitable Finance 192

Notes 193

Index 241

Dubbed by American Banker as “the sharpest mind analyzing banking policy today—maybe ever,” KAREN PETROU is one of the most influential experts on financial policy and regulation in the world. She is cofounder and Managing Partner of Federal Financial Analytics, a consulting firm that provides analysis and advisory services on legislative, regulatory, and public-policy issues. Known for nonpartisan analysis, Petrou has testified before many U.S. government agencies. She is frequently interviewed for expert commentary and her work has been featured in the Financial Times, Wall Street Journal, American Banker, and Marketplace. Recently, Petrou has been featured for her pro bono work developing a new financial instrument to speed treatments and cures for disabilities and diseases, starting with those that cause severe vision impairment. Karen lives in Washington D.C. with her husband Basil and guide dog, Zuni.

Economic inequality in America is a problem that is not going away. Even before the COVID-19 crisis wrought havoc on the economy, the disparity between the rich and the poor was at levels not seen since World War II.

Moonshot proposals to curb inequality in America include progressive tax reform aimed at the one-percenters, mass cancellation of student loans, and an overhaul of public education. While these may all be formidable weapons to fight inequality, they have little chance of clearing the necessary political hurdles in Washington.

Without bipartisan consensus, are we doomed to watch idly as the yawning gap between the rich and poor grows dangerously out of control?

As one of the most insightful policy observers in the world, Karen Petrou argues we’re looking for solutions in all the wrong places. In Engine of Inequality, she persuasively takes dead aim at the Federal Reserve as a crucial but unrecognized source of economic inequality and offers meaningful policy proposals that don’t require an act of Congress.

Since the 2008 financial crisis, inequality has been rapidly increasing in no small part because of policies enacted by the Federal Reserve. Monetary and regulatory policy may seem far afield from economic inequality—but who gets the money how is the mission-critical job of central banks such as the Fed, which move money across our financial system. Like it or not, the Fed’s policies have a profound impact on the balance of equality.

Petrou boldly suggests the Fed must pull its head out of the sand. She details the hard data showing how the Fed’s post-crisis policies have unintentionally exacerbated the problem: reliance on aggregate data like Gross Domestic Product (GDP) obscures the economic reality of American families, trickle-down programs that rescue financial markets only benefit the rich, ultra-low interest rates impede meaningful savings by the middle class and others.

Engine of Inequality unveils several pragmatic actions that the Federal Reserve can and should take immediately to reverse its adverse influence on economic inequality and use its power to move the money into a force for shared prosperity.

PRAISE FOR ENGINE OF INEQUALITY

“Karen Petrou, one of the world’s deepest financial thinkers, puts her finger on the proximate cause of the pre- and post-Covid enormous increase in the stock market and associated growth in extreme U.S. wealth inequality. It’s the Federal Reserve’s ongoing No-Cost Lender of First Resort Policy. Her book is a tour de force—brilliant, fundamental, elucidating, and engaging. It’s also a sad story about well-meaning policy boomeranging badly on the middle class.”

—Laurence Kotlikoff, Professor of Economics at Boston University, President of Economic Security Planning, and a New York Times bestselling author

“This book is highly critical of Fed policy and will receive a lot of attention, especially if Fed policy doesn’t work in the coming years.”

—Henry Kaufman, President, Henry Kaufman & Company

“Petrou’s book uncovers a hidden engine of our skyrocketing inequality: financial policy. In accessible and engaging prose, Petrou takes us through the inner workings of monetary policy at the Fed and financial regulations, how they’ve made inequality worse, and how they could instead be retooled to take us to a more equitable future. A novel look at the problem of inequality and bold ideas to help resolve it. A must-read.”

—Emmanuel Saez, Director of the Center for Equitable Growth at the University of California at Berkeley

“[Petrou] draws a direct connection between the Federal Reserve’s decisions and the rich getting richer, with others struggling to get by.”—New York Times DealBook

“Petrou’s excellent new book explains how it has been exacerbated and accelerated by the financial policies that were set in place to save the financial system from collapse after the crisis of 2007 and 2008.” —Dylan Schleicher, Editorial Director, Porchlight Books

“Karen Petrou has for decades played the quiet role of consultant and adviser to banks, central banks, and large investors, helping them slash through the confusion of constantly evolving monetary and regulatory policy. It’s a job that prioritizes dispassionate analysis over advocacy. Today, that changes, with the publication of her new book.”—Matt Peterson, Barron’s

“Banking consultant Karen Petrou is right that Federal Reserve policies have helped the rich.” —Peter Coy, Bloomberg BusinessWeek