Disinflationary Monetary Policy and the Distribution of Income

Inflation over the last 5 years has remained below 3 percent. Many economic observers applaud these results, arguing that inflation has ceased to matter much in the decisions of consumers and businesses. Others such as Martin Feldstein (1996), Lee Hoskins (1991), and Jerry Jordan (1993) advocate further gains on the inflationary front. Feldstein, for instance, argues that reducing the inflation rate to zero would ameliorate the tax distortions caused by inflation, producing substantial gains to the economy. He estimates that to achieve price stability the Federal Reserve would have to engineer a recession that reduces real gross domestic product by 5 percent. Feldstein holds that these costs are far outweighed by the benefits that would occur from reducing the misallocation of resources (in jargon, the deadweight losses) due to inflation. What he overlooks in his analysis is how the costs and benefits of such a policy would be shared. Who would bear the burdens from disinflationary monetary policy? Who would reap the benefits? Would such distributional consequences be desirable in the present economic environment? This working paper attempts to answer these questions first by considering based on economic principles how different sectors would be affected by disinflationary policy. The traditional "money" channel of monetary policy implies that employment in interest-sensitive industries should fall the most. The "credit" channel implies that small, financially-constrained firms should be hurt more than large, financially-stable firms. A slowdown in aggregate activity working through either channel would burden low-income workers more than high-income workers. Since minorities tend to have lower wages than whites, disinflationary policy should disproportionately affect them. Lenders such as bond holders would gain by an unanticipated decrease in inflation.