Does income inequality contribute to credit cycles?

Abstract

Recent literature has presented arguments linking income inequality on the financial crash of 2007 -2009. One proposed channel is expected to work through bank credit. We analyze the relationship between income inequality and bank credit in panel cointegration framework, and find that they have a long-run dependency relationship. Results show that income inequality has contributed to the increase of bank credit in developed economies after the Second World War. JEL classification: C23, D31, G21

Inequality, leverage and crises: Theory and evidence revisited

“…Fourth, the ratio of credit to GDP is again found to be influenced by the top 1% income share positively and significantly, and this result is robust to all regressions in Table as in Table . Such clear role of rising inequality for financial instability identified in our empirical work is completely the same as in Malinen (), Perugini et al. (), and Gu and Huang ().…”

“…We find significant evidence linking credit booms or financial crises to rising inequality and asset bubble. While this finding is in line with that in the other latest studies (e.g., Malinen, ; Perugini, Holscher, & Collie, ), our results on the effects of control variables are different from theirs.…”

Income inequality and banking crises: Testing the level hypothesis directly

“…Klein (2015) uses panel cointegration techniques, and shows that a long-run relation exists between income inequality and household debt. This result is consistent with Malinen (2016), who also finds a long-run steady-state relationship between the top 1% income share and domestic bank credit. In short, both the theoretical and empirical literature emphasize that income inequality is related to household debt only in the long-run, which implies that the level of income inequality (rather than the growth rate) is the suitable measure in this study.…”

The risk of financial crises: Is there a role for income inequality?

“…While its role on the onset of financial crises has recently been studied in a number of theoretical contributions, the empirical evidence is scant and mixed. Some papers find that income inequality increases the probability of financial crises (Roy and Kemme 2012) or drives credit booms (Perugini et al 2015;Klein 2015;Malinen 2016), whereas others do not find income inequality to be a consistent ingredient in the growth of bank loans (Bordo and Meissner 2012) or the development of financial crises (Atkinson and Morelli 2011). On the financial side, Schularick and Taylor (2012) point to credit booms as the primary contributor to financial crises in developed countries over the past 140 years (see also Lang and Schmidt (2016)).…”