Inequality, Instability, and the Household Balance Sheet Channel

This research project studies the macroeconomic effects of rising inequality by focusing not on top incomes but instead on the economics of the “bottom 99%” which has been squeezed out by rising inequality and falling labor shares.

One of the defining features of the bottom end of income distribution has been the lack of savings, falling wealth and rising indebtedness. This project relates those developments to the rise of inequality. How much of the observed fall in saving rates can be attributed to rising inequality? In what sense is inequality responsible for increased indebtedness? Are there significant relationships? And if so, what are the policy prescriptions, in a post-2008 world? What lessons can economists learn from rising inequality?

The existence of a link between rising inequality and a weakening of households’ balance sheets has far reaching implications. First, it opens up a field of research into the macroeconomics of rising inequality. Second, if rising inequality does indeed explain rising indebtedness, inequality can be held responsible for greater instability through the creation of asset-price bubbles. Third, there are stabilization policy implications. Rising private debt constrains monetary policy because monetary authorities cannot raise the interest rate too much without risking a wave of defaults. In that sense, the traditional role of monetary policy may need to be enlarged to prevent too much income disparity and indebtedness. Fiscal policy may also be called to the rescue of an economy which has crashed.