Policy choices have distributional consequences. This proposition is seen as self-evident in the context of certain macroeconomic policies such as fiscal policy that often have an explicit redistributive element. However, far less attention has been paid to the distributional consequences of a range of other macroeconomic and structural policies, with much of the analysis in the academic literature typically focused on aggregate consequences, especially in terms of growth and volatility.
In a new IZA discussion paper, Eswar Prasad argues that a broad range of macroeconomic policies – especially those related to monetary policy and financial regulation – can also have significant distributional consequences. The reason is that financial markets are incomplete, imperfect (e.g., due to information asymmetries), and economic agents’ access to them is often limited. Consequently, households cannot effectively insure against the asymmetric effects of such policies.
In emerging markets and low-income economies, underdeveloped financial markets, coupled with insufficient access to formal financial institutions, limit households’ ability to insure against household-specific shocks and magnify the distributional effects of aggregate macroeconomic fluctuations that may initially have only small effects.
While distributional consequences of policies are of intrinsic interest, a related and equally important question is whether these consequences in turn determine the choice of policy responses to specific shocks. According to the author, such choices, which often reflect the relative political power of different groups, can sometimes have deleterious aggregate consequences.
Prasad argues that it is important to explicitly recognize distributional rather than just aggregate consequences when evaluating specific policy interventions as well as the mix of different policies. This does not mean, for instance, that central bankers should include measures of inequality in their operating rules. Rather, it is a call for a more careful evaluation of welfare consequences of policies that do not just focus on aggregate outcomes.