Inequality breeds financial crises. Say what?

7 Apr

Seriously. It’s true. At least in the US. When—as appears to have happened in the long run-up to both crises—the rich lend a large part of their added income to the poor and middle class, and when income inequality grows for several decades, debt-to-income ratios increase sufficiently to raise the risk of a major crisis.An article that waits to be written is on how this played out in the Eastern and Southern European attempt to hide inequality through bank loans.

Here are the findings from a seemingly renegade team from…the IMF. The full text is here: kumhof

The United States experienced two major economic crises over the past 100 years—the Great Depression of 1929 and the Great Recession of 2007. Income inequality may have played a role in the origins of both. We say this because there are two remarkable similarities between the eras preceding these crises: a sharp in- crease in income inequality and a sharp in- crease in household debt–to-income ratios. Are these two facts connected? Empirical evidence and a consistent theoretical model (Kumhof and Rancière, 2010) suggest they are. When—as appears to have happened in the long run-up to both crises—the rich lend a large part of their added income to the poor and middle class, and when income inequal- ity grows for several decades, debt-to-income ratios increase sufficiently to raise the risk of a major crisis.

This means that if workers’ incomes are restored one stands better chances of avoiding crises.

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