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By Karen Petrou and Matthew Shaw

Yesterday, FRB Vice Chairman Clarida said that the U.S. economy is in “in a good place.”  However, The Fed’s new study of American economic “well-being” shows that huge swaths of the United States are struggling harder than ever before to make ends meet.  All but the most affluent Americans asked about how well they’re doing don’t feel anywhere near that good about it.  Combine this with new data on the evaporating American middle class and an ugly picture quickly merges.  In it, the prosperity in which the Fed takes such comfort rests thinly atop millions – indeed a hundred plus million – of Americans who are barely getting by at the height of the business cycle following a record-breaking “recovery.”  No wonder that so many Americans remain so angry about their economic prospects and why political polarization is sure to define the 2020 election at least as much as it determined 2016’s outcome.

Here are just a few key findings from the latest Fed report:

On income equality:

  • Think you’re broke?  26 percent of adults have a family income of less than $25,000, which was just about the federal poverty level for a family of four in the contiguous U.S. in 2018.  Another 11 percent have a family income above $25,000 but below $40,000.  Thus, more than one-third of Americans have family income below middle class as the Fed elsewhere defines it ($40,000).

On employment:

  • Only two-thirds of adults report that they are working as much as they want.  One in 10 are not working and want to work, while two in 10 are currently working but want to work more hours.  Labor participation thus is clearly not anywhere near as high as overall employment numbers imply.
  • 24 percent of prime-age adults reported not working in the month prior to the survey, with an about even split between those who did not want work and those who did but were unable to find it.  35 percent of those not working cite a health limitation and 23 percent said they could not find work.  As we have noted, disability is a profound barrier to labor participation despite the ability of many who want to work also to successfully gain paid employment.
  • 50 percent of blacks and 52 percent of Hispanics with a high school degree or less want to work more, compared to 31 percent of whites with the same level of education.
  • Three in 10 adults reported engaging in at least one gig activity in the month prior to the survey; 30 percent of respondents say they regularly earned money from gig activities in all or most months of the previous year.  Signs of financial fragility (i.e., difficulty handling a $400 unexpected expense, using alternative financial services) are slightly more common for gig workers and markedly higher for those who use gig work as their primary source of income.

On economic resilience:

  • The percentage of Americans who can handle a tire blow-out remains virtually unchanged. The share of Americans who would have difficulty handling a $400 emergency expense remains at about four in 10; 61 percent of adults say they could cover such an expense using cash, savings, or a credit card paid off at the next statement, up slightly from 59 percent last year and from only 50 percent in 2013.  27 percent say they would borrow or sell something to pay for the expense, and 12 percent cannot cover it at all.  The annual $400 resilience criterion is not adjusted for inflation and thus represents less purchasing power in each successive year. 
  • 17 percent of adults cannot pay all their monthly bills in full.  Another 12 percent would be unable to do so if they also faced an unexpected $400 expense.
  • Almost one quarter of adults skipped necessary medical care in 2018 because they were unable to afford it.  This jumps to 36 percent for those with a family income less than $40,000.  When income is greater than $100,000, eight percent of families still are forced to skip a medical treatment due to cost.  Four in 10 adults with medical expenses in the last year have unpaid medical debt.
  • Only 36 percent of non-retired adults think that their retirement saving is on track, and one-quarter have no retirement savings or pension at all. 

On racial, educational, and geographic disparities:

  • Gaps in reported economic well-being by race and ethnicity have persisted despite improvements in overall well-being since the Fed started the survey in 2013.  Nearly eight in 10 whites say they are “doing at least okay” financially, compared to only two-thirds of both blacks and Hispanics.
  • 87 percent of adults with a bachelor’s degree or higher report that they are doing at least okay financially, compared to only 64 percent of those with a high school degree or less. 
  • 66 percent of adults living in urban areas describe their local economy as either good or excellent, compared to only 52 percent of rural residents.

On intergenerational mobility:

  • More than one-quarter of adults under age 30 report receiving some form of financial support from someone outside their home (most often a parent). 
  • Only 17 percent of adults under age 30 whose parents did not attend college obtained a bachelor’s degree, compared to 71 percent of young adults who have at least one parent with a bachelor’s degree.  59 percent of young adults with parents that have a high school degree or less also have only a high school degree or less.

The post The Good, the Bad, and the Ugly in American Well-Being appeared first on Economic Equality.

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By Karen Petrou

When we started this blog in 2017, we began with a plea for the Federal Reserve to factor inequality into its monetary and regulatory policy equation.  We showed at the start, here, here and here, that the Fed’s focus only on averages and aggregates obscures sharp polarization at each end of the U.S. income and wealth distribution.  It is these polarizations, as we’ve repeatedly seen in blog posts that undermine the Fed’s ability to set the U.S. economy on a forward trajectory of shared prosperity and stable growth – i.e., to meet its dual mandate as Congress expressly defined it in the Humphrey-Hawkins Act of 1978.  The Fed is still resolutely crafting monetary policy with its eyes firmly averted from increasing inequality. 

However, at a conference last week, Chairman Powell and Governor Brainard at least now have acknowledged that the U.S. middle class has gone missing.  We take a look at what they say they know now and if anything will be different now that they know it.

The Middle-Class Abyss

That America’s middle class has been emptying out to larger and larger populations of lower and lower income households is not news.  We have detailed prior findings to this effect by the IMF looking at lost income, Fed staff research on lost wealth, an important look by Fed staff at income, wealth, and consumption baked into a multi-dimensional – not to mention depressing – assessment.  The OECD has also recently put out a study of the middle class’ sorry plight across advanced economies, concluding that the U.S. middle class is disappearing faster than anyone else’s.  We have numerous quibbles with the OECD methodology, but its cross-border comparison is nonetheless noteworthy – and also depressing.

In Gov. Brainard’s speech, she lays out her definition of the middle class, establishing a useful marker not only for debate, but also as a threshold by which to assess policies such as those of the National Credit Union Administration purporting to help low-income households.  The agency’s definition of “low income” applies to anyone with a family income that is the greater of eighty percent of the relevant area or the national median income.  The Fed’s definition of middle class is anyone in the 40% to 70% band around national median income.  Although the Fed’s definition is of course more generous than the NCUA’s, it is defining the middle- – not lower- – income stratum around the median. 

Where’s the money?

Using the Fed’s definition, Ms. Brainard then builds on recent Fed staff work creating a distributional U.S. financial account to assess an array of recent studies.  All of this research shows first that middle-class income has increased about one percent a year adjusted for inflation; over the same period, real GDP went up 2.6% a year.  As we’ve said, GDP isn’t the best way to judge economic growth if one cares about equality.  The Fed also notes that the top income decile doubled its income over the last thirty years. 

What else do we know?

  • The crisis did a lot of damage to the middle-class. The wealth of the top 10% is 19% higher than it was before the crisis, even taking stock-price declines late last year into account.  Middle-income family wealth is still below where it was before the financial crisis, lower-income families lost 16% of their pre-crisis wealth (not much to start with, of course).
  • The average wealth of the top 10% is 13 times higher than that of the middle class; it was only 7 times higher in 1989 when inequality had already been rising for at least a decade. Now, the top 10% has more wealth than the remaining 90% of the U.S. population.
  • Liabilities of the average middle-income household (i.e., debt) have nearly doubled in thirty years; assets have increased only 50%.
  • In 2016, the average wealth of white households ($933,700) was seven times the average wealth of black households ($138,200) and five times that of Hispanic households ($191,200). Even among households at the middle of the income distribution, 2016 average white-household wealth ($277,200) was roughly one and a half times that of black households ($179,700) and nearly three times that of Hispanic households ($95,400).
  • Only about 25% of middle-income households could handle expenses for six months in the absence of regular income. One-third of middle-class households cannot handle an unexpected $400 expense.  One-fourth of middle-class households also skipped some medical care because they couldn’t handle its cost.  Anyone doubting this should look at the immediate distress of millions of government workers and contractors during the last government shutdown. 
  • On the positive side, middle-class retirement savings increased 2.5% a year over the past thirty years, giving these households a better retirement cushion than ever before. Interestingly, retirement savings are about double the wealth percentage for middle-class households as equity in a home, refuting the nostrum that the largest source of wealth for this sector is in a home.  Average middle-income household home equity peaked at $90,200 in late 2005 and declined by almost two-thirds through 2011.  By the end of 2018, average middle-class home equity was still below pre-recession peak and not much above the value in 1989.
  • Importantly, retirement-savings data are not adjusted for age; when they are, a third of non-retired households have enough on which to retire and 16% have no retirement savings; the Fed believes this shift largely reflects the change-over from defined-contribution to defined-benefit plans over the past thirty years – i.e., the older you are, the more likely you are to have a pension and the better your wealth accumulation.

Now What?

Despite all these compelling data, Chairman Powell only bemoans them; he suggests no issues that the Fed might wish even to consider.  Gov. Brainard is more forthcoming – she suggests that middle-class hollowing out could well alter consumption patterns and thus redefine macroeconomic growth.  Next up, though, is just more work by the Fed to understand distributional differences.  Whether even this will be part of the Fed’s ongoing examination of monetary policy is left unsaid but it has so far not figured in the Federal Reserve Board’s work plan to reassess U.S. monetary policy in light of its weak post-crisis results and enormous cost to the Fed.

The post The Missing Middle Class appeared first on Economic Equality.

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Economic Equality Blog by Karen Petrou - 2M ago

By Karen Petrou

As we have noted, here and here, the Fed is devoting increasing analytical – if not yet policy-maker – attention to the unequalizing impact of unconventional policy.  It’s a start – a major problem besetting central banks in countries without a robust middle class – i.e., the U.S. – is that old-school representative-agent thinking leads to unanticipated, unequal outcomes when wealth and income are disproportionately enjoyed by the very few, very rich.  It is for this reason that the Fed’s touted employment benefit and “robust” economy in the wake of post-crisis policy has done so little for so many who remain so angry.  A new Fed paper helps to show why.

The “representative-agent” model does not have anything to do with who’s selling your house.  It means that econometric assumptions, including the theories on which monetary policy is premised, assume everyone in an economy is pretty much the same as everyone else.  When the majority of the population is within large bands of similar income, wealth, and propensity to consume, then representative-agent assumptions work as a good guide to how an economy will respond to changing interest rates or other actions.  Most Fed thinking is based on representative-agent models, which is why much hasn’t worked anywhere near as well as the Fed hoped.  The U.S. is now what economists call “heterogeneous” that is, small groups of people have a huge impact on the economy because income and wealth are so unevenly distributed and marginal propensity to consume has shifted to a few people who don’t want all that much of what’s needed to stoke output growth. 

Correctly recognizing all this, the new Fed staff paper goes down the heterogeneous route to see what monetary policy does to those who need growth the most.  It’s very, very econometric and model-driven, but still a helpful neo-Keynesian foray.  Instead of looking at American workers as one great big group, the analysis breaks them down from 1985-2006 by educational level (an increasingly helpful, if distressing, equality indicator). 

Looked at this way, one finds that conventional monetary-policy easing reduces employment inequality – i.e., more people are working – but wage inequality gets still worse for those who can afford it the least.  Monetary-policy contraction also reduces employment among lower-skilled workers, but does not do so for more highly-educated ones, exacerbating income inequality.   

Why so unequal an impact?  The paper is highly theoretical despite all its data, but postulates that more highly-educated employees are more mobile and thus less sensitive to monetary-policy shock.  We would add that, when the majority of the population is mid-to-low skilled, then monetary policy is at best a blunt-force instrument because most workers have difficulty finding full-time employment that supports consumption above the hand-to-mouth level that is similarly unresponsive to policy stimulus or constraint.

In short, this paper shows that conventional policy doesn’t work by the book when it comes to low-skilled workers.  We would add that, because conventional policy doesn’t work for workers, it also hasn’t worked for pretty much everyone else.  Is this also true for post-crisis unconventional policy?

Sadly, yes.  Unconventional policy actually tracks convention by relying in part on interest rates, albeit by driving them down to ultra-low levels in hopes of ensuring ultra-fast recovery.  The employment-mobility issues described in this paper apply at least as much in an unconventional take on conventional interest-rate changes because employment becomes still harder for low-skilled workers.  The labor-participation data shows this all too clearly. 

Of course, unconventional policy also counts on a huge Fed portfolio. As we’ve shown, the portfolio largely affects wealth equality – or inequality given its clear impact boosting financial-asset valuations at disproportionate benefit to the upper stratum of the U.S. wealth distribution.  The Fed has made the same representative-agent mistake with its portfolio that it did with interest rates: when wealth was relatively evenly distributed and held in more or less the same assets, then market stimuli transmit across the economy.  But, when wealth is held heterogeneously – that is by a few people in assets most others don’t have – then market stimuli do not transmit in ways that result in increasing physical-infrastructure spending or the other economic investments that boost sustained employment growth for low-skilled and even middle-class workers.  And, so we’ve seen since 2010.     

As a result, Fed policy hasn’t worked.  The Fed knows this all too well – it’s studying hard and holding conferences and even allowing its researchers to spend the time it takes to provide studies such as this happily-heterogeneous one.  There’s still, though, no sign that policy-makers are doing more than modeling new “neutral rates,” playing with “inflation targets,” or commissioning doctoral dissertations on other modifications of current policy into the old batch of representative-agent assumptions.  Unless the models change, monetary policy won’t and most will be the poorer for it. 

The post The Low-Skill Losers appeared first on Economic Equality.

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By Karen Petrou

It’s easy enough to miss the macroeconomic and financial-sector impact of giant tech-platform companies in the swirl of concern about privacy, political integrity, concentration, and corporate governance.  However, big tech also has massive macroeconomic impact with far-reaching financial-system implications.  We explored safety-and-soundness implications in here and economic-equality impact in here.  Now comes a sweeping IMF study linking and even attributing structural economic transformation to these same big-tech behemoths.  Although inconclusive in critical respects, it’s worth a careful look.

The IMF study looks at one million companies across 27 mostly advanced countries over the past two decades.  Key findings are that:

  • Corporate power has risen “moderately” across advanced economies. The U.S. leads the way to monopoly-land with a sharp increase in high-productivity, high mark-up non-manufacturing (i.e., tech) firms.
  • Market power reduces innovation as it increases, contributing also to the sharp drop in private fixed investment (25% since the crisis) in advanced economies that otherwise might have been corrected by ultra-low interest rates, higher profitability rates, and higher expected returns on capital.
  • Following the 2008 financial crisis, rising market power may have marginally amplified the recession, pushed central banks to rely even more on unconventional monetary policies, or both.
  • The U.S. exhibits “winner take most” network effects in which high-productivity firms generate high mark-ups by driving out inefficient companies. This increases innovation, but only to a point – the more market power, the less innovation over time.
  • Adverse output and unexpected monetary-policy results may derive not only from increased market power, but also from the combination of this power with increased globalization and reduced antitrust enforcement.
  • Rising market power reduced labor’s share of income by about ten percent of the overall decline, contributing markedly to growing wage inequality. Because powerful U.S. firms gained share at the expense of weaker firms, the labor-share inequality impact is even stronger here.

How could four or five companies exert so much macroeconomic impact?  They couldn’t do it on their own, but the lack of a robust U.S. middle class combines with tech-platform dominance to transform the macroeconomic impact of traditional monetary-policy transmission.  This fuels yield-chasing which gives still more of a financial lift to big-tech companies that in turn suppresses output growth to result in one heck of a negative feedback loop.

The post Big Tech, Big Macroeconomic Problems appeared first on Economic Equality.

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By Karen Petrou

The Fed is listening.  In a recent blog post, we analyzed a brand-new database which Fed staff have constructed to capture distributional wealth effects across the U.S. economy.  Now, we turn to a brand new paper from the president and staff of the Federal Reserve Bank of St. Louis that not only recognizes the distributional impact of monetary policy – a Fed first – but tries to do something about it.  The paper proposes an “optimal” monetary policy based on a complex model with several uncertain assumptions, no conclusion about whether it would work in concert with a still-huge Fed portfolio, and nothing more than a theoretical hypothesis.  Still, it’s a start.

How Optimal, Equal Might Work

For all one might disagree with aspects of this paper, its fundamental contribution is to reject representative-agent hypotheses of monetary policy – which unsurprisingly dispute distributional impact – in favor of heterogeneous actors viewed in terms of income, wealth, and consumption equality.  We have done so before, noting the failures of aggregate data that Paul Krugman more colorfully described:  “If Jeff Bezos walks into a bar, the average wealth of the bar’s patrons suddenly shoots up to several billion dollars – but none of the non-Bezos drinkers has gotten any richer.” 

As outlined, a nominal-GDP monetary policy attempts to smooth GDP across an individual’s life cycle to reflect the natural transition of Americans from younger, poorer, debt-laden men and women to the middle-aged level of presumed comfort on to later-in-life periods of lower income and declining wealth.  Equality-oriented optimal monetary policy is then premised on price levels, a sharp departure from the inflation-level focus of the Fed in recent years.  The price level (defined by a new approach also crafted by this paper’s authors) is then set counter-cyclically to ensure that the real interest rate is always being pressed towards the neo-Keynesian neutral rate.  This is said then to result in stable nominal GDP that reduces inequality.  As real shocks occur, policy pushes back to the neutral rate via nominal GDP.  Recurring shocks alter nominal GDP, inflation moves higher as part of the counter-cyclical price adjustment – in short, the economy runs hot for a while as Janet Yellen considered towards the end of her Fed term. 

Possible Optimal Pitfalls

Score a big one for the St. Louis Fed on the path to optimal, equal monetary policy.  But, as its authors readily acknowledge, this paper is premised on a simple, stylized model based on a lot of income inequality – that would be us – and a large private-sector credit market – ditto.  Thereafter, analytical questions abound.

First, the model starts all actors at the same point and then varies factors such as productivity to ascertain life-cycle equality.  As Piketty made clear, inequality is a cumulative cycle or, as others have determined, inequality economics are characterized by inter-generational immobility in which children of the rich start better off than everyone else and children of the poor start farther behind where their parents began a generation ago.  It is not clear to us if the model would derive its optimal results if inequality began at the outset instead of increasing over the life-cycle absent its new monetary-policy counter-pressure.

Second, and even more fundamentally, aiming monetary policy at a stable nominal GDP may be less equalizing than the paper hopes because GDP is a lot less equal than the paper acknowledges – see here for a discussion of why.

Third, this model is extremely abstract.  It recognizes U.S. income, wealth, and consumption inequality by running its life-cycle models by inequality data (about which we have some quibbles), but it does not ponder the question of how its policy would be implemented.  This may seem like a second-order question, but it’s an immediate issue because Fed post-crisis policy has demonstrably made U.S. income and wealth inequality worse all on its own.  See here and other blog posts for an extensive discussion of how quantitative easing backfired with minimal long-term output impact but considerable, direct benefits to equity valuations that then enrich portfolios comprised of financial assets held – as new Fed data again demonstrate – largely by the very rich.  Ultra-low interests also exacerbate income inequality, especially in the absence of meaningful, distributed output growth.

Thus, if the Fed sought to implement this optimal policy through quantitative easing or even if it just perpetuated its plans now to hold close to $4 trillion, it’s at best unclear if optimal policy would make an equality dent.  Similarly, if “optimal” policy went below low interest rates into ultra-low territory, still more equality damage would ensue.

The post In Search of Optimal, Equal Monetary Policy appeared first on Economic Equality.

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By Karen Petrou

On Friday, March 22, the Federal Reserve finally conceded that aggregates and averages mask all-important economic facts, issuing for the first time the “Distributional Financial Accounts of the United States” (DFA).  This will be a quarterly staff assessment of U.S. wealth equality – or, as its data forcefully demonstrate, the lack thereof.  However, the DFA does something more:  it also tracks wealth inequality across the business-cycle over almost three decades, showing clearly that equity-price increases exacerbate wealth inequality.  As a result, the more the Fed strengthens the stock market by keeping rates low and its portfolio huge, the worse U.S. wealth inequality grows. 

With worse inequality also comes greater financial-crisis risk.  Placating markets as the Fed did yet again in January protects the Fed from short-term volatility at the cost of long-term catastrophe – too high a price for any new normalization that does not take inequality fully into account.

What the Fed Found

The DFA is an awesome undertaking in which Fed staff combine the quarterly Financial Accounts of the United States and the triennial Survey of Consumer Finances.  Doing this poses an array of methodological challenges which make numerous modifications, corrections, and assumptions critical to the DFA’s conclusions.  As with most wealth analyses, data problems increase as one ascends to the tippy-top of the one percent.  Any survey no matter if conducted for the Fed is unlikely to capture high-wealth households due to the difficulty of penetrating privacy barriers and reluctance to answer questions about vast holdings which may or may not be on the books.  Significant data variances also affect less exalted factors, with consumer debt a particularly problematic – but important – concern.  For example, Fed staff dismiss some methodological challenges – e.g., missing overdraft and payday loan data – on grounds that outstandings are small percentages of the total; they are, of course, big debts for lower-income people and thus raise another challenge to how thoroughly distributional the new DFA may be.

That said, most work – our own included – relies on only one of these two indicators.  Merging them in an attempt to capture unobserved distributions is instructive and then some.  Breaking the U.S. into the top 1%, the next 9%, the next 40%, and finally the lowest 50%, the DFA finds that:

  • The U.S. has gotten far less equitable in terms of wealth since 1989. Further, a lot more wealth is concentrated in the top 1%.  In 1989, the 1% had 23% of wealth; at year-end 2018, it was 32%, or a 39 % increase.  At the end of last year, this bottom 50 percent’s wealth share was a “barely visible” line in the relevant figure.  It’s not news that the U.S. is a lot more unequal, but it’s important that the most complete mapping to date of what households own and owe comports with different inequality methodologies.  Confirming our prior analyses and some others, the DFA also finds that the top one and ten percent gains here come largely at the expense of what we once liked to call the middle class.  This is largely due to significant valuation increases in concentrated holdings of corporate and non-corporate equity.  Durable goods and even homes do far less for wealth, making the Fed’s market-stabilization policy a boon for the investor class.
  • The DFA methodology permits better tracking of wealth data in comparison to business and credit cycles than the longer-term and often slow data provided by the World Inequality Database and other sources. Bringing data through 2018, the DFA shows a sudden halt in the inexorable inequality trend in the fourth quarter of 2019 – i.e., when the markets dove and the Fed got spooked.  As the Fed exercised its put and markets recovered in the first quarter of 2019, the DFA’s cycle predictor anticipates renewed inequality. 

The analysis says nothing further about what this means beyond detailing the interaction of equity prices with its various inequality measures and market trends.  What all these data show, though, is that the Fed has struck a Faustian bargain:  keeping interest rates low and maintaining a huge portfolio that stokes equity markets and exacerbates inequality.  This may keep a bit of seeming recovery going a little longer, but only at the cost of still more inequality which makes the risk of a financial crisis even greater.  In short, nothing may be as procyclical as the Fed’s own policies.

The post Greenspan’s Market Put is Powell’s Inequality Short appeared first on Economic Equality.

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By Karen Petrou

On March 12, the Financial Times ran one of Martin Wolf’s insightful columns, this one focusing on a critical facet of post-crisis monetary policy – ultra-low interest rates – to see why so much monetary-policy firepower had had such minimal macroeconomic impact.  Mr. Wolf suspects that the secular stagnation first framed by Lawrence Summers means that ultra-low real rates are here to stay due in part to economic inequality.  However, what if ultra-low rates on their own exacerbate inequality and thus create a negative feedback loop with dangerous implications not only for long-term growth and financial stability, but also for inequality?  Considerable evidence shows that ultra-low rates are inextricably intertwined with extra-high inequality.  Fed thinking on the new neutral rate thus must prick the traditional neo-Keynesian bubble to ensure that Chairman Powell’s new normalization isn’t a path to still worse inequality.

The Traditional Perspective

Traditional neo-Keynesian thinking has yet to accept the secular-stagnation construct or the balance-sheet recession hypothesis variation on this theme. But, even if the Fed moves on to recognize this new paradigm, there are still two reasons not addressed in secular-stagnation analysis that, the lower the interest rates, the worse the inequality and then, the worse the inequality, the lower the rates.  Traditional neo-Keynesian and secular-stagnation theory neglect the impact of negative rates on small savers and assume that low interest rates enhance equality due to increasingly affordable debt.  Low-rate corporate debt is also supposed to spur productivity and thereby boost employment.  All of this would be to the good of equality, but only had any of it happened.

Ultra-Low Rates and Wealth Inequality

When interest rates are ultra-low, wealthy households with asset managers acting on their behalf can play the stock market to beat zero or even negative returns.  We’ve shown in several recent blog posts how wide the wealth inequality gap is and how disparate wealth sources help to make it so.  However, even where low-and-moderate income households can get into the market, their investment advisers should not and often cannot chase yields.  As a result, ultra-low rates mean negligible or even negative return.

Historically, pension funds and insurance companies have invested only in the safest assets.  These are now in scarce supply due in large part to QE and comparable programs by central banks around the world.  Pension plans and life-insurance companies increasingly have two terrible choices:  to play it safe and become increasingly unable to honor benefit obligations or to make big bets and hope for the best.  Under-funded pension plans are so great a concern in the U.S. that the agency established to protect pensioners from this risk, the Pension Benefit Guaranty Corporation, faces its own financial challenges.  Yield-chasing life insurers are also a prime source of potential systemic risk.

The importance of these programs and products to economic equality is evident not only in volumes of research about the need for retirement savings, but even in the actions of Americans in the post-crisis period.  Despite all of the pressures on moderate-income households during the crisis and the recession in its wake, households are putting away what they can to protect themselves and their families.  The “precautionary” savings balances of moderate-income households have slightly increased since the crisis even though their savings dwindle to less and less under the ultra-low rates small savers are able to earn in interest from a bank or similarly-secure institution.

As a result, and in sharp contrast to the rapid rise in valuation and return on the financial assets wealthy households own, savings accounts now are only a bit of insulation against unexpected expenses, not a wealth-accumulation engine.  One recent study estimated a total loss across the U.S. economy of $2.3 trillion in savings-accounts and similar balances due to the very low interest rates that prevailed from 2008 through 2016.

Further, ultra-low rates do not have offsetting equality benefit due to lots of low-cost loans with which lower-income families might fund wealth accumulation and small businesses can fire up the income engine.  A study of over a hundred global banks found that reductions in short-term rates are less effective as growth stimulants when interest rates are ultra-low, even after controlling for the changes in loan demand occurring after a financial crisis and differences among the banks surveyed.  A study by Federal Reserve Bank of New York staff narrows this question to the U.S., also finding that lending drops as rates approach the zero lower bound (ZLB) because banks simply can’t make money making ultra-low interest rate loans.  This same study also finds that banks adjusted to persistent low rates by changing their asset/liability mix away from deposit-taking and longer-term lending to less costly funding sources and short-term, interest-bearing investments such as excess reserves held at the Federal Reserve.  As a result, the mix of monetary policy, regulatory requirements, and business-reality factors leads banks in an ultra-low rate environment to reduce lending, especially for the longer-term, lower-cost loans critical to wealth accumulation.

But, wasn’t there a burst of lower-rate mortgage refinancings that allowed households to reduce their debt burden and thus accumulate wealth?  Did low rates allow higher-risk households at least to reduce their mortgage debt through refinancings?  Again, low-and-moderate income households were left behind.  They continued to seek refis after the financial crisis ebbed, but subprime borrowers current on their loans regardless of loan-to-value (LTV) ratios were less likely than prime or super-prime borrowers to receive refi loans even though higher-scored borrowers may or may not have been current and lower rates enhance repayment potential.

What about Income Inequality?

Clearly, the low interest rates that characterize secular stagnation are not only caused by inequality, but also cause it with regard to wealth accumulation.  Worse still, ultra-low rates exacerbate income inequality, hollowing out opportunities for inter-generational mobility from start to finish.

A new research paper shows that low interest rates also exacerbate income inequality due to their direct and adverse impact on competition and, as a result, productivity.

This study combines what it calls a traditional macroeconomic effect – i.e., lower rates mean more productivity – with a strategic effect – i.e., what firms actually do as rates fall to ultra-low levels.  This study uses theoretical models and empirical data to show that productivity rises as interest rates fall, but only to a point.  When rates start to approach the ZLB, then productivity drops because market concentration increases due to lower expansion costs and pre-existing market power at the largest firms.

A brand new paper from the Federal Reserve Bank of Philadelphia buttresses this argument with its own data and model.  These build out the strategic rationale powering up big companies during low-rate periods, showing that large firms operate at higher leverage than smaller or more monoline ones, leading to increased concentration and lower productivity as big companies muscle out a declining number of start-ups.

The obvious rebuttal to this productivity and concentration argument is that unemployment seems low.  However, as we’ve shown before, wage growth is negligible in real terms and labor-participation rates remain, at best problematic.  If ultra-low rates spark concentration, could it be that this concentration suppresses wages and concentrates employment at the top of the skill level?  Nobel Prize winner Joseph Stiglitz has hypothesized that giant firms concentrate so much economic power that they set wages and otherwise control pricing and production across the economy to disadvantage low-and-moderate income households.

What do all these studies tell us about ultra-low rates and economic equality? 

The income-inequality nexus to ultra-low rates is less clear than the damaging wealth-inequality impact.  Still, there’s more than enough here to warrant a very hard look at the extent to which any fed policy premised on continuing low rates will make inequality even worse and the nation still more rancorous.  The Fed plans to study post-crisis monetary policy, but it’s failed to put economic equality into the equation.  Clearly, it’s past time to do so.

The post Ultra-Low Rates and Extra-High Inequality appeared first on Economic Equality.

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By Matthew Shaw

Absent geopolitical or market surprises, the current U.S. expansion will by summer be the longest consecutive period of economic growth on record.  That’s the good news.  The toxic side-effect of all this prosperity:  how little of it is equitably shared and how angry that makes the majority of Americans ahead of the next election.  If income and wealth growth over the 2016-2019 period tracks 2010 to 2016, then the middle class will be no better off in 2019 than 2001 even with almost a decade of aggregate growth.

Disaggregated data from the Federal Reserve triennial Survey of Consumer Finances (SCF) show clearly that middle-class households have fallen further behind higher-earning ones during the post-crisis recovery.  While top U.S. earners now exceed their pre-crisis highs in terms of both income and wealth, the middle class will need to see significant gains in both income and wealth growth rates over its post-crisis average just to get back to where it was in 2007.

Below, we assess trends in both income and wealth across the income distribution, showing not only that inequality is increasing, but that this increase can be attributed to gains by those at the top and losses for the rest of the distribution.

Income

Headlines at the start of 2019 happily proclaimed that worker wage gains hit their highest level in a decade: over three percent.  Unfortunately, this fails to account for inflation, 1.9 percent last year according to the BLS.  In real terms, wages rose only about one percent – better than nothing, but not nearly enough to make up for the real – that is, inflation adjusted – overall income all but the top quintile of households lost.

Wages are only one component of income, but for most households, they make up the bulk of household income.*  From 2010 to 2016, the top ten percent of earners’ median income increased by 14.7%, while the bottom four quintiles could only muster single-digit growth.  What is truly startling, however, is that the middle three quintiles have median incomes that, on an inflation adjusted basis, remain lower not only than their pre-crisis highs, but also their 2001 levels (i.e., before any bubble associated with the run-up to the financial crisis).  With specific regard to the middle quintile, median real income since 2001 is down 2.6% and stood at $52,700 in 2016, while the top ten percent’s median income has risen 13.2% to $260,200 over this same period.  Were the middle quintile’s median income to grow between 2016 and 2019 at the same rate as between 2010 and 2016, then it would still remain below its 2001 level when adjusted for inflation.

Importantly, real dollars are also at stake.  While median income is up for all quintiles since the end of the crisis, this growth has not been even, as shown in the chart below. 

Median value of before-tax family income:

Percentile of Income
Year Less than 20 20-39.9 40-59.9 60-79.9 80-89.9 90-100
Level (thousands of 2016 dollars)
2001

2010

2016

13.9

14.8

15.1

33.0

31.0

31.4

54.1

50.6

52.7

87.8

79.2

86.1

133.8

124.7

136.0

229.8

226.9

260.2

Change (percentage)
2010-2016

2001-2016

2.0

8.6

1.3

-4.8

4.2

-2.6

8.7

-1.9

9.1

1.6

14.7

13.2

Source: Federal Reserve Survey of Consumer Finances (2016)

Wealth

While these income data are startling, the wealth data contained in the SCF are downright frightening. As with income, the top of the distribution has now regained the wealth lost during the financial crisis: the top-ten percent of earners increased their median net worth in real terms by 24.3 percent between 2010 and 2016, with the next ten percent increasing their median net worth by 23.3 percent. 

As for everyone else? 

The middle class – those households whose incomes fall in the middle quintile of the income distribution – increased median net worth by 12 percent; the lowest quintile became 4.4 percent poorer.

Not so bad for the middle class?  Importantly, Americans start from very different places, making the differences in wealth-growth levels all the more meaningful in terms of real prosperity measured in real dollars adjusted for inflation.  The median net worth for the top ten percent was already at $1.3 million in 2010 prior to growing to $1.6 million – the highest median reported in any SCF – over the next six years.  This is also considerably above where it stood in 2001 ($1.1 million). 

Median middle-class wealth was only $72,800 in 2010, rising to $81,500 by 2016 but still $4,700 below its 2001 level.  Thus, when middle class households say the economy isn’t working for them, they’re not wrong; real median wealth was lower in 2016 than it was in 2001 for all but the highest quintile of earners.  If median middle quintile net worth continues to grow from 2016 to 2019 at its 2010-2016 rate, then it will eclipse its 2001 level, but just barely.  Regardless, the negligible growth projected over almost two decades pales in comparison to the top ten percent’s median wealth increase of more than half a million dollars between 2001 and 2016 and projected increase of $710,000 from 2001 to 2019.  As always, it’s important to note that median wealth data in the top decile are misleading due to the significant concentration of assets in the top one percent  ($17.6 million average wealth) and significant wealth-reporting challenges as assets ascend to the stratosphere.

Median value of net worth:

Percentile of Income
Year Less than 20 20-39.9 40-59.9 60-79.9 80-89.9 90-100
Level (thousands of 2016 dollars)
2001

2010

2016

10.6

6.8

6.5

50.7

28.3

32.3

86.2

72.8

81.5

195.5

142.1

168.3

356.5

316.8

390.6

1129.4

1320.0

1640.1

Change (percentage)
2010-2016

2001-2016

-4.4

-38.8

14.1

-36.3

12

-5.5

18.4

-13.9

23.3

9.6

24.3

45.2

Source: Federal Reserve Survey of Consumer Finances (2016)

Conclusion

Something’s different in the post-crisis era that has fundamentally altered how the middle class has recovered compared to previous recessions.  Growth rates for top decile median wealth vary greatly from report to report and are likely idiosyncratic because the wealthy depend on financial activities for a significant portion of this growth, introducing significant volatility.  However, middle quintile median wealth since 1989 – the first year the Fed conducted the triennial SCF in its current form – had experienced relatively constant growth since the end of the recession in the mid-1990s, growing 18.9 percent from 1992 to 1998, 18.6 percent from 1995 to 2001, 16.1 percent from 1998 to 2004 (despite the 2001 recession), and 18.3 percent from 2001-2007.  From 2010 to 2016, middle quintile median net worth as noted above grew 12 percent, only two-thirds of its pre-crisis, good-times growth rate. 

We’ll have to wait until the 2019 SCF to see if this trend has changed, with recent, positive wage data correlating with improving income and wealth growth for the majority of Americans and not just those at the top of the income distribution.  But even a return to pre-crisis growth trends won’t change the damage that’s already been done: 15 years of sitting in neutral for some, many going in reverse, and only the best-off among us in drive.  

* For the purposes of this post, income is defined as the Fed defines it in the SCF: the sum of a household’s wages, self-employment and business income, taxable and tax-exempt interest, dividends, realized capital gains, food stamps and other related support programs provided by the government, pensions and withdrawals from retirement accounts, Social Security, alimony and other support payments, and miscellaneous sources of income for all members of the primary economic unit in the household.  Wealth – used here interchangeably with net worth – also follows the Fed definition as contained in the SCF and is the difference between a family’s gross assets and their liabilities.  All dollar values are in 2016 dollars unless otherwise noted.

The post A Paradox: U.S. Growth and Who Got Left Behind appeared first on Economic Equality.

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By Matthew Shaw

Absent geopolitical or market surprises, the current U.S. expansion will by summer be the longest consecutive period of economic growth on record.  That’s the good news.  The toxic side-effect of all this prosperity:  how little of it is equitably shared and how angry that makes the majority of Americans ahead of the next election.  If income and wealth growth over the 2016-2019 period tracks 2010 to 2016, then the middle class will be no better off in 2019 than 2001 even with almost a decade of aggregate growth.

Disaggregated data from the Federal Reserve triennial Survey of Consumer Finances (SCF) show clearly that middle-class households have fallen further behind higher-earning ones during the post-crisis recovery.  While top U.S. earners now exceed their pre-crisis highs in terms of both income and wealth, the middle class will need to see significant gains in both income and wealth growth rates over its post-crisis average just to get back to where it was in 2007.

Below, we assess trends in both income and wealth across the income distribution, showing not only that inequality is increasing, but that this increase can be attributed to gains by those at the top and losses for the rest of the distribution.

Income

Headlines at the start of 2019 happily proclaimed that worker wage gains hit their highest level in a decade: over three percent.  Unfortunately, this fails to account for inflation, 1.9 percent last year according to the BLS.  In real terms, wages rose only about one percent – better than nothing, but not nearly enough to make up for the real – that is, inflation adjusted – overall income all but the top quintile of households lost.

Wages are only one component of income, but for most households, they make up the bulk of household income.*  From 2010 to 2016, the top ten percent of earners’ median income increased by 14.7%, while the bottom four quintiles could only muster single-digit growth.  What is truly startling, however, is that the middle three quintiles have median incomes that, on an inflation adjusted basis, remain lower not only than their pre-crisis highs, but also their 2001 levels (i.e., before any bubble associated with the run-up to the financial crisis).  With specific regard to the middle quintile, median real income since 2001 is down 2.6% and stood at $52,700 in 2016, while the top ten percent’s median income has risen 13.2% to $260,200 over this same period.  Were the middle quintile’s median income to grow between 2016 and 2019 at the same rate as between 2010 and 2016, then it would still remain below its 2001 level when adjusted for inflation.

Importantly, real dollars are also at stake.  While median income is up for all quintiles since the end of the crisis, this growth has not been even, as shown in the chart below. 

Median value of before-tax family income:

Percentile of Income
Year Less than 20 20-39.9 40-59.9 60-79.9 80-89.9 90-100
Level (thousands of 2016 dollars)
2001

2010

2016

13.9

14.8

15.1

33.0

31.0

31.4

54.1

50.6

52.7

87.8

79.2

86.1

133.8

124.7

136.0

229.8

226.9

260.2

Change (percentage)
2010-2016

2001-2016

2.0

8.6

1.3

-4.8

4.2

-2.6

8.7

-1.9

9.1

1.6

14.7

13.2

Source: Federal Reserve Survey of Consumer Finances (2016)

Wealth

While these income data are startling, the wealth data contained in the SCF are downright frightening. As with income, the top of the distribution has now regained the wealth lost during the financial crisis: the top-ten percent of earners increased their median net worth in real terms by 24.3 percent between 2010 and 2016, with the next ten percent increasing their median net worth by 23.3 percent. 

As for everyone else? 

The middle class – those households whose incomes fall in the middle quintile of the income distribution – increased median net worth by 12 percent; the lowest quintile became 4.4 percent poorer.

Not so bad for the middle class?  Importantly, Americans start from very different places, making the differences in wealth-growth levels all the more meaningful in terms of real prosperity measured in real dollars adjusted for inflation.  The median net worth for the top ten percent was already at $1.3 million in 2010 prior to growing to $1.6 million – the highest median reported in any SCF – over the next six years.  This is also considerably above where it stood in 2001 ($1.1 million). 

Median middle-class wealth was only $72,800 in 2010, rising to $81,500 by 2016 but still $4,700 below its 2001 level.  Thus, when middle class households say the economy isn’t working for them, they’re not wrong; real median wealth was lower in 2016 than it was in 2001 for all but the highest quintile of earners.  If median middle quintile net worth continues to grow from 2016 to 2019 at its 2010-2016 rate, then it will eclipse its 2001 level, but just barely.  Regardless, the negligible growth projected over almost two decades pales in comparison to the top ten percent’s median wealth increase of more than half a million dollars between 2001 and 2016 and projected increase of $710,000 from 2001 to 2019.  As always, it’s important to note that median wealth data in the top decile are misleading due to the significant concentration of assets in the top one percent  ($17.6 million average wealth) and significant wealth-reporting challenges as assets ascend to the stratosphere.

Median value of net worth:

Percentile of Income
Year Less than 20 20-39.9 40-59.9 60-79.9 80-89.9 90-100
Level (thousands of 2016 dollars)
2001

2010

2016

10.6

6.8

6.5

50.7

28.3

32.3

86.2

72.8

81.5

195.5

142.1

168.3

356.5

316.8

390.6

1129.4

1320.0

1640.1

Change (percentage)
2010-2016

2001-2016

-4.4

-38.8

14.1

-36.3

12

-5.5

18.4

-13.9

23.3

9.6

24.3

45.2

Source: Federal Reserve Survey of Consumer Finances (2016)

Conclusion

Something’s different in the post-crisis era that has fundamentally altered how the middle class has recovered compared to previous recessions.  Growth rates for top decile median wealth vary greatly from report to report and are likely idiosyncratic because the wealthy depend on financial activities for a significant portion of this growth, introducing significant volatility.  However, middle quintile median wealth since 1989 – the first year the Fed conducted the triennial SCF in its current form – had experienced relatively constant growth since the end of the recession in the mid-1990s, growing 18.9 percent from 1992 to 1998, 18.6 percent from 1995 to 2001, 16.1 percent from 1998 to 2004 (despite the 2001 recession), and 18.3 percent from 2001-2007.  From 2010 to 2016, middle quintile median net worth as noted above grew 12 percent, only two-thirds of its pre-crisis, good-times growth rate. 

We’ll have to wait until the 2019 SCF to see if this trend has changed, with recent, positive wage data correlating with improving income and wealth growth for the majority of Americans and not just those at the top of the income distribution.  But even a return to pre-crisis growth trends won’t change the damage that’s already been done: 15 years of sitting in neutral for some, many going in reverse, and only the best-off among us in drive.  

* For the purposes of this post, income is defined as the Fed defines it in the SCF: the sum of a household’s wages, self-employment and business income, taxable and tax-exempt interest, dividends, realized capital gains, food stamps and other related support programs provided by the government, pensions and withdrawals from retirement accounts, Social Security, alimony and other support payments, and miscellaneous sources of income for all members of the primary economic unit in the household.  Wealth – used here interchangeably with net worth – also follows the Fed definition as contained in the SCF and is the difference between a family’s gross assets and their liabilities.  All dollar values are in 2016 dollars unless otherwise noted.

The post A Paradox: U.S. Growth and Who Got Left Behind appeared first on Economic Equality.

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By Karen Petrou

On February 13, bipartisan Senate Banking leadership asked for views on how best to craft a new consumer-data privacy and security framework.  Reflecting 2017’s Equifax debacle, the inquiry seems rooted in the credit-reporting framework.  Essential though it is, data-integrity fixes for the credit bureaus aren’t anywhere near sufficient protection now that consumer financial data are increasingly clutched in the hands of Facebook, Amazon, Google, and an array of lightly- or un-regulated technology-based consumer-finance providers.  As we have demonstrated, sustainable, sound, and fair consumer credit is critical to economic equality. 

Households with no margin of financial error and more debt than  most can already repay under stress are uniquely vulnerable to financial products that over-look or over-charge them or that use personal data to pitch unsuitable products.

The U.S. consumer-finance system in 2019 is a Model T welded to a Maserati – that is, who can offer which products under what rules hasn’t changed much since 1987, when the still-permeable barriers between banking and commerce were crafted, and 1999, when financial services could be paired with taking insured deposits was laid out.  The Dodd-Frank Act of 2010, for all it did to consumer protection via the CFPB, made few changes to the structure of U.S. finance.

It is thus possible for like-kind deposit, loan, payment, and advisory services to originate inside and outside the bank-regulatory framework, often with considerable safety-and-soundness risks to providers and the broader financial system.  Some counter this assertion on grounds that only banks may offer FDIC-insured deposits or access Fed liquidity backstops, but backdoor access to these benefits combine with consumer assumptions that all providers of like-kind products have like-kind safeguards to make this difference increasingly nothing more than a statutory nicety.

With Senate Banking’s invitation in hand, this blog post turns to our prior calls for like-kind rules for like-kind products, laying out the questions Congress must quickly resolve if it hopes to craft a robust, forward-looking consumer-data framework that protects the most vulnerable households and their equality-essential financial data.

What’s the difference between innovative cross-selling and improper product tying?

Banks have demonstrated that cross-selling can be problematic even without use of big data.  However, old-school cross-selling violations transgress clear rules and are subject to stringent, if sometimes belated, enforcement.  But, unless cross-selling is fraudulent, deceptive, or can be considered “abusive,” no rules govern the ability of a non-bank to share the data a consumer provides for one service – e.g., a “free” look at a candidate’s views – with financial data provided by the consumer in a free search for credit – then to pitch a very lucrative investment vehicle based on a consumer’s beliefs and the means to back them.  Is this innovative?  Maybe, but it’s also highly problematic if the investment product is unsuitable for the consumer due to risk or cost or if it’s selected principally because it profits the platform company. 

What pricing subsidies benefit consumers and which unduly profit the provider? 

Bank holding companies are barred from tying – i.e., mandating that a consumer wanting a loan also purchase insurance.  A raft of disclosures also applies when traditional banking products are marketed in conjunction with other financial services.  Again, bank-regulatory enforcement could be better – way better.  Still, for tech companies, only fraudulent, deceptive, or abusive behavior is barred – and perhaps not even then given limited FTC authority. 

Technology-based finance providers thus could demand that you use their “free” social-media services if you want also to send money to your home-country relatives via a remittance service along the lines Facebook contemplates.  What about “exclusive” products such as hot Christmas toys available only to consumers who also select a platform company’s credit card, installment loan, or other financial offerings?  Many merchants discount goods if a consumer takes out a sponsored card.  None so far can mandate that you buy something to get a loan or condition the product on taking out costly credit. 

Where does advanced underwriting stop and bias begin? 

Algorithms are built to accomplish the objective set for them by humans and only that objective unless or until machine learning is programmed up-front to achieve more than one goal.  Assuming as one reasonably may that technology-based financial companies will be as profit-driven as traditional providers, how will they use their far deeper databases?  Will it be to ensure compliance to rules about which coders may not know and do not care because their own incentives lie elsewhere? 

It’s as illegal to discriminate in a tech-based finance model as a traditional one, but who’s to know?  New York State has begun to require insurance underwriters to validate the non-discriminatory results of their underwriting models, which now include at least one claiming to provide life insurance based on nothing more than what an algorithm thinks of an applicant’s face.  Are comparable standards warranted at the federal level and for all financial offerings, not just insurance?  What if, for example, you knew about higher-yielding deposit options only if a tech company thought you worthy based on its data or what it made of them?  Banks must accept funds from anyone who can see a sign on the branch door, may hear an ad, or is told by a friend about an interest rate on offer.  When rates are based on nothing more than what one looks like or where one lives according to a geocoding model, who will get the best offer or, indeed, any?

Indeed, how much choice will consumers have with highly-personal data that are used to target, cross-sell, cross-subsidize, or otherwise enhance powerful platform-company profit engines? 

Banks may not deny deposit services to anyone whose looks they don’t much like nor can payment services be withheld or loans withdrawn on any basis other than demonstrable credit risk.  However, just as platform companies target employment ads only to white males or market short-term rentals to majority, non-disabled travelers, so too could certain financial products powered up by platform companies be offered only to or demanded from targeted populations.

Are banks all that much better?

In the wake of my recent Financial Times opinion piece on tech finance and equality, numerous comments complained that banks had done so much social ill that only tech providers could ensure financial inclusion.  Nothing here or elsewhere in our tech-finance work defends banks – what we aim to do is illuminate the rules under which banks operate and to which they can be held accountable. 

When banks use AI, ML, or whatever comes next to innovate, these rules still apply and regulators and the courts are there to enforce them.  If the banks fail to comply or the government fails to make them do so, more shame on them.  At least, though, there’s a mechanism that protects vulnerable households. 

These protections are at best fragile when the product comes from a tech platform, with the awesome data on which these companies thrive making risks still greater.  This is the asymmetry Senate Banking must confront – regardless of how it is improved, a data-privacy regime applied only to regulated financial providers leaves a lot of room for still worse economic inequality.

The post Hard Questions on Data Privacy appeared first on Economic Equality.

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