Wednesday, February 9, 2011

Inequality, leverage and crises (ls)

The IMF published a very interesting working paper. See also this article on voxeu for a short version.

Key thesis:

"Rising inequality in a climate of rising consumption can lead poorer households to increase their leverage, thereby making a crisis more likely."

The descriptive evidence seems to be striking:

The simulation results of their model look insightful as well:

Their reasoning is supported by several additional arguments:
  • Rajan (2010) argues that rising inequality creates a political incentive to facilitate the access of poorer people to mortgages and consumer loans.
  • Fitoussi (2010) points out that rising inequality leads to an increase of the average propensity to save since rich agents tend to save a larger share of their income. This consequently brings down the average propensity of consumption and causes a persistent weakness in aggregate demand. Central banks respond to this developement by loosening their policy stance, thereby giving rise to the build-up of financial imbalances.
All in all, this seems to be a very interesting point which hasn't been stressed prominently yet.