Inequality, deregulation, credit growth and crisis

Authors: Holscher, J., Collie, S. and Perugini, C.

Conference: Pacific Rim conference

Dates: 24-26 April 2013

Abstract:

In the three decades leading up to the late-2000s financial crisis, economic inequality rose across much of the developed world. This has led many to question whether rising inequality might, in some way, be partly responsible for creating financial fragility. At the heart of this debate is the question of whether rising inequality leads to private sector credit booms, which are, in turn, widely accepted as a macroeconomic risk factor. Despite growing interest, empirical evidence on an inequality-fragility relationship is limited. That which does exist fails to tip the balance of evidence conclusively one way or the other. This research adds to this scarce body of evidence. Based on an econometric analysis of a panel of fourteen countries covering the period 1970-2008, this study finds a statistically significant, positive relationship between income inequality (as measured by the top 1% income share) and private sector indebtedness (measured as private sector credit as a percentage of GDP) when controlling for ‘conventional’ credit determinants. The implications of such a relationship are twofold. First, the view that the distribution of income is irrelevant to macroeconomic outcomes (which dominates mainstream economic thought) needs a second look. Second, if policy makers wish to make the financial system more robust, they should cast the net wider than micro reforms and consider the effects of changes to the distribution of economic resources

Source: Manual