Federal Reserve Board research finds unexpected 25 basis point monetary policy tightenings raise metro-area labor income inequality driven by bottom-decile earnings declines

The Federal Reserve Board published a FEDS Note analysing how unanticipated shifts in the monetary policy stance affect income inequality across US metropolitan areas. Using IRS tax-return data aggregated to the zip code level, the note finds that contractionary monetary policy surprises tend to increase, and expansionary surprises tend to decrease, income inequality, with most of the effect operating through labor income and concentrated among lower-income workers. The analysis constructs within-metropolitan-area inequality measures from IRS Statistics of Income data for 1998–2019 and identifies monetary policy surprises from changes in federal funds futures around Federal Open Market Committee announcements. An unexpected 25 basis point tightening is estimated to raise total income inequality gradually over the following two years, peaking at slightly more than 1 percent in year t+2 before fading and becoming statistically indistinguishable from zero by year t+4. The labor income response is larger and more persistent, with a 25 basis point cumulative tightening associated with an increase of about 3 percent in the P90/P10 ratio of salaries and wages over a four-year horizon, driven by relatively larger declines in earnings at the bottom of the labor income distribution from year t+2 onward. Where local labor markets are weak, the policy-induced increase in earnings inequality is amplified, with the P90/P10 ratio rising by an additional 0.5 percentage points in year t+2 and by another 1 percentage point in years t+3 and t+4, an effect attributed entirely to larger declines at the bottom of the distribution.