Rising Global Inequality: How Can Fiscal and Monetary Policies Be Reformed to Promote Fairer Economies?

Global inequality is increasing, posing risks to economic stability, social cohesion, and long-term growth. While the rapid development of emerging markets has narrowed income gaps between countries, disparities within nations continue to widen. The COVID-19 pandemic exacerbated these inequalities, straining public finances and limiting governments’ ability to respond to crises. With more low-income countries facing debt distress and economic shocks becoming more frequent, a crucial question arises: how can fiscal and monetary policies be reformed to promote inclusive and sustainable growth?

At the request of the UN Committee of Experts on Public Administration (CEPA)—which advises member states on strengthening governance and public administration to achieve the Sustainable Development Goals (SDGs) under the 2030 Agenda—we have prepared a guidance note on promoting equitable fiscal and monetary policies. This note, expected to be released to member countries soon, outlines key policy recommendations. This blog post summarizes our main findings.

The role of fiscal and monetary policies in reducing inequality

Governments have two primary macroeconomic tools for shaping economic outcomes: fiscal policy (taxation and public spending) and monetary policy (money supply and interest rates). While fiscal policy is widely recognized as the main driver of redistribution, monetary policy also plays an important role. However, policies in several emerging and low-income developing economies (EMDEs) have often fallen short in delivering equitable outcomes.

Fiscal policy: The primary tool for redistribution

Progressive taxation and well-targeted public spending are essential for reducing inequality. Yet, in many EMDEs, tax systems rely heavily on regressive indirect taxes, such as value-added taxes, rather than progressive income and wealth taxes (see figure). At the same time, limited fiscal space often results in inadequate public spending. Investments in education, healthcare, and social protection—which are crucial for reducing inequality—are often constrained by high debt levels. At the same time, inefficient targeting of spending results in these outlays having very weak effects on income distribution.

Monetary policy: An overlooked factor in equity

Monetary policy is primarily designed to control inflation and maintain economic stability, but its impact on income and wealth distribution is often underestimated. High inflation disproportionately hurts lower-income households, as they tend to hold more cash and have fewer financial assets that appreciate in value. Over the medium term, tight monetary policy to control inflation does not necessarily lower economic growth, real wages, or employment. This suggests that maintaining low inflation is compatible with a broader strategy for equitable growth. Furthermore, well-designed monetary policy frameworks—such as inflation targeting—can foster fiscal discipline, which is crucial for long-term economic stability.

In the short run, tightening monetary policy to reduce inflation can exacerbate income inequality by slowing economic activity and increasing unemployment. This underscores the importance of adequate safety nets to protect the poor.

The relationship between monetary policy and the distribution of wealth remains mixed in the empirical literature. On the one hand, low interest rates increase asset values, disproportionately benefiting higher-income groups who own financial assets. On the other hand, lower interest rates can result in an unforeseen inflationary surge, which might lead to a shift in wealth from creditors to debtors. This could potentially benefit middle-income households with mortgages and home ownership. However, most studies on this topic predate the COVID pandemic and the sharp rise in asset valuations since 2020. Given these significant economic shifts, further research is warranted to understand the effects of accommodative monetary policies on wealth inequality.

The path to more equitable policies

A rethinking of fiscal and monetary policies is needed to align them with equity objectives. Several key reforms can help:

1. Reforming tax systems for fairer outcomes
   • Expanding progressive taxation, including personal income taxes, corporate taxes, and wealth taxes. A key priority for income taxes is lowering the filing threshold to broaden the tax net while raising rates on income from capital. Expanding property taxation would help address the adverse effects of rising asset prices on wealth inequality.
   • Closing loopholes and reducing tax exemptions that primarily benefit the wealthy.
   • Strengthening domestic tax capacity in low-income countries to boost revenues without excessively burdening lower-income households.
2. Targeting social spending more effectively
   • Expanding cash transfer programs to low-income groups while ensuring that their design does not discourage labor market participation.
   • Increasing investments in health, where spending is still too low to achieve universal health care. Public resources should focus on primary and preventive care to strengthen health outcomes.
   • Improving the composition of spending in education by reallocating resources toward primary and secondary schools and optimizing the mix of spending (e.g., between wages and teaching materials). Greater efforts on learning outcomes and the quality of teaching, especially in low-income regions, are essential.
   • Reforming government subsidies, such as fuel subsidies, by shifting from blanket approaches to targeted programs for the most vulnerable.
3. Monetary policy with a social lens
   • Given inflation’s adverse effects on inequality, EMDEs should adopt monetary policy frameworks that maintain inflation at moderate levels of no more than 5-10 percent per year. Nevertheless, EMDEs should expand their fiscal toolkit to protect the unemployed, mitigating the short-term effects of monetary tightening on poverty and inequality.
   • Many countries that target control of inflation rely on flexible exchange rates. However, in EMDEs with structural weaknesses--such as shallow foreign exchange markets—exchange rate intervention may be warranted to limit excessive currency depreciation and its inflationary effects. The policymakers should carefully weigh the trade-offs of such interventions.
   • Greater transparency and communication in monetary policymaking can help reduce uncertainty for lower-income households.
   • Stronger coordination between monetary and fiscal policy is crucial to prevent conflicting objectives that undermine inclusive growth.

Institutional strengthening: The missing piece

Good policies are not enough—they must be supported by strong institutions. Strengthening public financial management, ensuring fiscal responsibility, and enhancing the independence and accountability of central banks are essential for effectively implementing equitable macroeconomic policies. Countries with strong institutions are better equipped to mobilize revenues, target spending effectively, and achieve low or moderate rates of inflation, fostering economic growth while protecting vulnerable populations.

A global call for action

The UN’s 2030 Agenda for Sustainable Development highlights the urgent need to combat inequalities within and across countries. However, achieving this goal requires a fundamental shift in how policymakers approach fiscal and monetary policies. Governments must take decisive action to reform tax systems, improve public spending, and refine monetary policy to build fairer and inclusive economies. By prioritizing equity and sustainability, policymakers can ensure that economic growth benefits all segments of society—not just a privileged few.

The road ahead is challenging, but with the right reforms and strong political commitment, a more equitable economic future is within reach.