Inequality, debt, and the financial crisis

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The New York Times
May 3, 2012

Inequality, debt, and the financial crisis

Recent research by economists from the International Monetary Fund and academia offers some new insights about income inequality, with important implications.

The researchers compared the top 5 percent of United States households from 1983 to 2007 with the remaining 95 percent. What they found is that as the rich got richer in the decades before the Great Recession, everyone else tried to maintain his standard of living by going deeper into debt. As income inequality grew over that period so did debt levels, because the rich increasingly invested their growing wealth in bonds and bank deposits, in effect providing money for ever more lending to the poor and middle class.

The top group's increasing wealth, and the bottom group's increasing reliance on debt, spurred the growth of the financial sector. But with ever increasing debt, the financial system -- and the broader economy -- became ever more vulnerable to crisis.

The data is eye-opening. In 1983, the top 5 percent had 80 cents of debt for every dollar of income, while the remaining 95 percent had 60 cents for every dollar. By 2007, after decades in which an increasing share of income flowed to the top, the situation had reversed. The top 5 percent had 65 cents of debt for every dollar of income, while the remaining 95 percent had $1.40 in debt for every dollar. The situation remains skewed today.

The first step in restoring real stability to the economy is to lower the debt levels through what the researchers call "orderly debt reduction." An example of that would be mortgage modifications. The second and more important step is to reduce income inequality by raising wages, possibly by strengthening collective bargaining.

Income inequality and high household debt are not the only explanations of the financial crisis. But the researchers make a compelling case that greater equality and lower debt could make future crises less likely.

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This page contains a single entry by CFED published on May 11, 2012 6:13 PM.

The deadliness of income inequality was the previous entry in this blog.

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