The Circular Relationship Between Inequality, Leverage, and Financial Crises

Abstract

In this paper, we put into perspective the recent literature which points to inequality as a possible cause of credit bubbles, by reintegrating it into a more general analysis on the two‐way relationship between inequality and finance. We focus more specifically on situations where high inequalities and widespread access to credit coexist, and argue that, even when institutions maintain more or less equal access to finance, there may be a dynamic, positive circular relationship between inequality and financial development. However, even if there is some evidence in the literature of a positive causal impact of inequality on credit, this does not preclude other important, cofounding factors. The conclusions concerning the distributional impact of finance are more ambiguous. A survey of the empirical literature highlights several issues that must be tackled. First, endogeneity: reverse causality and coincidental factors are major concerns. Second, the choice of consistent measurements for the key variables (both credit and inequality) has strong empirical implications, and must be grounded on relevant theoretical channels. Third, those circular dynamics have substantial policy implications for emerging economies, since an increasing number face a joint increase in inequality and credit.

An investigation of the effects of income inequality on financial fragility: Evidence from Organization for Economic Co‐operation and Development countries

“…In particular, the coefficient of income inequality is positive and significant at every level of significance, an outcome that is consistent with the existing literature (Kumhof et al, 2015;Bellettini & Delbono, 2013;Perugini et al, 2015;Kumhof et al, 2015;Kirschenmann et al, 2016;Yamarik et al, 2016;Bazillier & Hericourt, 2017). In particular, the coefficient of income inequality is positive and significant at every level of significance, an outcome that is consistent with the existing literature (Kumhof et al, 2015;Bellettini & Delbono, 2013;Perugini et al, 2015;Kumhof et al, 2015;Kirschenmann et al, 2016;Yamarik et al, 2016;Bazillier & Hericourt, 2017).…”

“…6 However, Krueger and Perri (2006) argue that income inequality may not be an accurate indicator of wealth inequality as part of nonlabour income is transitory and does not have any effect on permanent income (Bazillier & Hericourt, 2017). 6 However, Krueger and Perri (2006) argue that income inequality may not be an accurate indicator of wealth inequality as part of nonlabour income is transitory and does not have any effect on permanent income (Bazillier & Hericourt, 2017).…”

Inequality and crises revisited

“…The available empirical evidence provides fairly ambiguous answers to this question, as also described in a recent survey by Bazillier and H'ericourt (2014). On one hand, the nexus between growing inequality and the occurrence of a crisis is deemed not to be backed by significant statistical evidence across different countries and time periods (e.g.…”

Egalitarianism and the Great Recession: A Tale of Missed Connections?

“…What remains to be seen is how economic divergence can create financial instability, and it is this to which I now turn. My analysis here builds on a growing literature that explores this link (Bazillier and Héricourt 2014;van Treeck 2014;Perugini et al 2013;Wisman 2013;Holt and Greenwood 2012;Kumhof 2012;Maestri and Roventini 2012;Stockhammer 2012;Galbraith 2012;Atkinson and Morelli 2011;Lysandrou 2011).…”