Does Inequality Lead to a Financial Crisis? Revisited

Abstract

Financial crises have been attributed to rising income inequality via its induced high household leverage as observed in the USA and similar economies. Alternatively it has been suggested this is not a general relationship since it was found that inequality had no bearing on crises in 14 advanced countries over 1920-2008; instead, low interest rates and business cycle expansions are found to be the only two robust determinants of credit booms leading to crises. Using a similar dataset, this paper provides no support for the generality of the above findings by embracing country heterogeneity. The paper shows that real evidence still points back to the inequality-leverage-crisis nexus for financialized economies. The implication is that finance can hardly be sustainable under rising inequality.

Expenditure Cascades, Low Interest Rates or Property Booms? Determinants of Household Debt in OECD Countries

“…In contrast we fail to find evidence for a positive link between an increasingly polarized distribution of income and household indebtedness as reported by several authors (Behringer & Treeck 2013;Gu & Huang 2014;Kumhof et al 2012;Klein 2015;Malinen 2014;Perugini et al 2016). We think our paper is different in three key aspects which explain the differences in the results.…”

“…When it comes to the effects of interest rates, results are mixed. Perugini et al (2016) find no statistically significant effect, Bordo and Meissner (2012) find a statistically significant negative effect and Gu and Huang (2014) report a statistically significant positive effect. Klein (2015) and Malinen (2014) are motivated by previous empirical studies and the lack of cointegration tests therein.…”

“…The Financial Crisis triggered by the collapse of the US mortgage market has motivated a wave of empirical studies which look at the relationship between the trend of rising income inequality and household indebtedness (Klein 2015;Perugini et al 2016;Gu & Huang 2014;Malinen 2014;Behringer & Treeck 2013;Bordo & Meissner 2012;Kumhof et al 2012). Most of these studies are motivated by the theoretical work of Rajan (2010) and Kumhof and Rancière (2010) and do not estimate theory-derived structural models but rely on ad hoc specifications instead.…”

“…They find a positive impact of top income shares on private sector debt. Gu and Huang (2014) and Bordo and Meissner (2012) in contrast use long data series going back to the 1920s and the logarithmized difference of real private sector debt as their dependent variable. The latter do not find a positive impact of top income shares whereas the former do claim to find such a relationship but it hinges on interacting the inequality measure with GDP growth.…”

“…However their paper does not distinguish between household and business debt and it does not take property prices into account. Bordo and Meissner (2012), and, similar, if critical, Gu and Huang (2014) investigate the effect of inequality on debt over a long period , but do not control for real estate prices or financial regulation. Also none of these studies allows or tests for potential long run relationships.…”