Inequality and crises: coincidence or causation?

Paul Krugman Top 1% share 25.00

20.00

15.00

10.00

5.00

0.00

1961 1965 1969 1913 1917 1921 1925 1929 1933 1937 1941 1945 1949 1953 1957 1973 1977 1981 1985 1989 1993 1997 2001 2005

Source: Piketty and Saez Pre-2008: When I would talk to lay audiences about inequality, I would mention that we were reaching levels not seen since 1929 – and that would inevitably lead to questions about whether we would soon have another Depression. No, I’d say – there really isn’t a clear reason why high inequality should lead to macroeconomic crisis.

And then …. Sources: Eichengreen and O’Rourke, World Trade Monitor So a return of inequality to 1920s levels was followed by a financial crisis similar to the onset of the Great Depression. Why? Three possibilities:

1. Coincidence

2. Common causation – e.g., neoliberal ideology

3. Actual causation: inequality somehow creates macroeconomic vulnerability Sharp rightward shift in politics in US and to lesser extent UK circa 1980. Reflected in polarization, and also in policies – including financial deregulation.

Also, strong correlation between political shifts and inequality. Source: Poole and Rosenthal

Source: Campbell and Hercowitz So political shifts may have led both to rising inequality and to a more vulnerable financial system

But might there be a direct causal link from inequality to macro crisis?

Hobson’s choice: underconsumption theory Robert Reich: “The problem wasn't that consumers lived beyond their means. It was that their means didn't keep up with what the growing economy was capable of producing at or near full-employment. A larger and larger share of total income went to people at the top.

“So in the longer term, it's hard to see where the buying power will come from unless America's vast middle class has more take-home pay.”

But underconsumption has both conceptual problems and empirical troubles. Consumption share of GDP 72

70

68

66

64

62

60

58

56

1950 1974 1983 1998 2007 1947 1953 1956 1959 1962 1965 1968 1971 1977 1980 1986 1989 1992 1995 2001 2004 Modern ideas: overconsumption (and over-indebtedness), not underconsumption

Frank: “The wealthy are spending more now simply because they have more money. But their spending has led others to spend more as well, including middle-income families. If the real incomes of middle-class families have grown only slightly, how have they financed this additional consumption? In part by working longer hours, but mainly by saving less and borrowing more.”

Also see Warren-Tyagi on bankruptcies. Inequality and household debt 200 25.00 180 160 20.00 140 120 15.00 100 debt1 80 10.00 debt2 top1share 60 40 5.00 20

0 0.00

1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003

Sources: Piketty-Saez, Historical Statistics, Federal Reserve Politics

? Financial Inequality fragility