Monetary Policy and the Distribution of Income: Evidence from U.S. Metropolitan Areas 
Despite the importance of the nexus between monetary policy and income inequality, empirical analysis of that connection, especially for the United States, is scant. This paper uses publicly available IRS income data aggregated to the Zip code level to provide new evidence showing how monetary policy affects income inequality across US metropolitan statistical areas (MSAs). It exploits the time series and geographical variation of these data over the past two decades (1998 through 2019) in combination with monetary policy surprises derived from high-frequency financial data.
Key Findings
- Contractionary monetary policy surprises increase income inequality, and most of this effect is due to the response of labor income (income attributed to salaries and wages).
- More specifically, labor income inequality (the ratio of labor income at the top decile of the income distribution to labor income at the bottom decile of the distribution within each MSA) increases about 0.75 percent per year, on average, over a four-year horizon in response to an unanticipated 25 basis point tightening of monetary policy.
- The bulk of this increase is due to the decline of earnings at the bottom of the labor income distribution.
- This effect of a monetary policy surprise on labor income inequality is notably more pronounced when the local unemployment “gap” is positive and the local unemployment rate is higher than the national average—that is, the local labor market is already fragile.
Implications
The paper’s findings suggest that the Federal Reserve’s monetary policy actions have economically significant indirect effects on income inequality through the labor market and that these effects are uneven across the distribution of labor income. While the magnitude of the paper’s estimates is not large enough to account for the rise in US income inequality over the past two decades, the results do support the view that monetary policy contributes meaningfully to cyclical fluctuations in income inequality, as policy-induced changes in aggregate demand differentially affect individual earnings.
Abstract
We use Zip code–level Statistics of Income data from the Internal Revenue Service to measure the distribution of income within U.S. metropolitan areas from 1998 through 2019. Exploiting geographic variation in income distribution over time, we study how unanticipated changes in the monetary policy stance shape the subsequent dynamics of income inequality. The results show that monetary policy persistently affects labor income inequality and that these distributional effects are amplified significantly in weak local labor markets.