from Project Syndicate, The Invention of Inequality by Antonio Foglia

Piketty observes a rising wealth-to-income ratio from 1970 to 2010 – a period divided by a significant change in the monetary environment. From 1970 to 1980, the Western economies experienced rising inflation, accompanied by interest-rate hikes. During that period, the wealth-to-income ratio increased only modestly, if at all, in these countries.

From 1980 on, nominal interest rates fell dramatically. Not surprisingly, the value of wealth rose much faster than that of income during this period, because the value of the assets that comprise wealth amounts essentially to the net present value of their expected future cash flows, discounted at the current interest rate.

What impact do lower interest rates have on measured inequality? If I own one house and my neighbor owns two, and falling interest rates cause the value of those houses to double, the monetary inequality between us also doubles, affecting a variety of statistical indicators and triggering much well-intended concern. But the reality is that I still own one house and my neighbor still owns two. Even the relative affordability of houses doesn’t change much, because lower interest rates make larger mortgages possible.

For further evidence of this phenomenon, consider Piketty’s own data. In Europe, Piketty singles out Italy as the country where the wealth-to-income ratio rose the most, to about 680% in 2010, compared to 230% in 1970. Germany appears to be a more “virtuous” country, with a wealth-to-income ratio of 400%, up from 210% in 1970. What Piketty fails to highlight is that, over this period, interest rates fell much more in Italy (from 20% to 4%) than in Germany (from 10% to 2%).

The real-world impact of this dynamic on inequality is precisely the opposite of what Piketty would expect. Indeed, not only are Italians, on average, much richer than Germans; Italy’s overall wealth distribution is much more balanced.

Clearly, economic inequality is a highly complex phenomenon, affected by a wide variety of factors – many of which we do not fully understand, much less control. Given this, we should be wary of the kinds of radical policies that some politicians are promoting today. Their impact is unpredictable, and that may end up doing more harm than good.

HKO

I have covered several aspects of inequality and the difficulty of measuring it, but this article shows how the dramatic fluctuations in interest rates in the 1980s influenced Piketty’s data, durin gthe time period he noted.

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