It’s a macroeconomic truth is that low income (and debt constrained) households tend to spend any extra money they receive while richer households tend to save it. In technical terms they have a large marginal propensity to consume.
Win win policy
This means that when inflation is low and the economy is faltering one of the most efficient ways to stimulate the economy is to send money to these income-constrained households. They promptly spend most of the transfer and help support the broader economy. This is a policy win-win. A single transfer policy can help stabilise the macroeconomy, while simultaneously reducing poverty and inequality and generally being quite popular.
And that's exactly what we say during the GFC and the Covid-19 crisis. Big spending policies were unfurled that both supported the economy at the aggregate level while reducing inequality at the same time.
You could in theory stimulate the economy solely by aiming tax cuts at the rich, but it would be incredibly inefficient requiring much larger deficits and increases in the debt. Even then you wouldn’t be guaranteed of success as wealthy households have the capacity to save every dollar you throw at them. That is why even nominally conservative governments usually target low income households when aggregate spending needs to rise.
Recession-fighting policies essentially have in-built progressive bias.
Heads I win, tails you lose
However when inflation is high and aggregate demand needs to be restrained that win-win dynamic flips on its head
The quickest way to reduce aggregate spending would be to decrease transfer payments to households that will be most likely to cut back on their spending. This means cutting transfers to low income households and/or those with little liquid savings. So your optimal inflation fighting policy would be terrible on a poverty and inequality front - especially if supply shocks are raising the cost of living more generally.
You can attempt to slow the economy by taxing the wealthy, but it will be hard. Their consumption does not respond as much to changes in their income (especially temporary changes) so you might have to whack them by a really large amount to get a meaningful reduction in spending.
And a large enough tax on wealthy households would come with a host of other unpleasant microeconomic impacts eg such as decreasing labour supply.
You could try and reduce public spending instead of the private variety. But this suffers from the same inequality-deflation trade off. Government spending disproportionately benefits low income households. Cutting public spending in the name of reducing inflation will still lead to a higher burden on low income Australians.
The inconvenient truth is that reducing aggregate demand is just a lot harder and a lot more likely to be unfair than increasing aggregate demand.
It’s at this point in the post that one should typically bring out this one weird economic trick that might resolve this sticky dilemma. However I don’t think there is any easy policy fix.
Tighter monetary policy is probably the fairest way to decrease aggregate demand. Higher interest rates encourage everyone to save, regardless of where they sit on the income spectrum.
Indeed most research concludes that any link between monetary policy and economic inequality is weak and unclear at best. While low income households are most likely to suffer from a rise in the unemployment rate, the wealthy will suffer from the falls in asset prices that higher interest rates generate.
There are no easy solutions to decreasing aggregate demand. But monetary policy remains the least worst policy option.
PS. You might also be interested in…
Stephen Kirchner’s substack on Australian economics! He also follows the most recent gyrations of the Australian economy - including the ongoing Review of the RBA. He is particularly knowledgeable about the history of Australian macro policy - and has been talking about the issues with LAW and monetary policy since before I joined the RBA!
Unfortunately, his substack is now going behind a paywall, though I believe there is a free trial option and discounts for student and those stuck in academia - though if you are willing to give him a plug on your own substack he has promised a year’s free content (while that nudge has affected the timing of this endorsement it has not affected the content)!