Monetary Policy and Inequality Links: Should Central Banks be Concerned?

Abstract

In this article, the link between monetary policy and inequality is investigated using the vector auto regression based impulse response functions. The study was motivated by persistent high income inequality in South Africa and the COVID-19 pandemic has renewed the debate on the links between monetary policy and inequality. South African annual time series data from 1990 to 2021 was used to examine the relationship between monetary policy and inequality. The impulse response functions show that the overall income distribution is briefly improved following a monetary policy shock. The findings suggest a fluctuating effect of monetary policy on inequality of which after period six a shock to monetary policy has no effect to inequality since the relationship reaches a stable state. The policy implication is the countercyclical use of monetary policy to reduce inequality is only effective in the early phases and in the long term the effect of monetary policy on inequality is reduced. The policy suggestion is that monetary policy alone cannot tackle inequality in an economy with other structural challenges that are outside of the monetary system. Hence policy coordination between monetary policy and fiscal policy is essential.