The Impact of Inequality on Macroeconomic Dynamics

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In the last few years the impact of income distribution on macroeconomic dynamics has received growing academic attention.

Above all the subprime crisis and the increasing indebtedness of private households in the United States have been attributed to the growing inequality in the United States and attempts to address inequality by broadening access to housing loans and home ownership (Rajan 2010, p. 43, Kumhof and Rancière 2010, Fitoussi and Saraceno 2010). Kumhof et al. (2012) go even further by identifying “a clear empirical and theoretical link” between the increase of inequality over recent decades and deteriorations of countries’ current account balances. The most encompassing approach can be found in a paper by Berg and Ostry (2011, p. 16) who show for a large sample of countries that “growth and inequality-reducing policies are like to reinforce one another and help to establish the foundations for a sustainable expansion”.

In this paper I will analyze the experience of the more recent period from 1995 to 2005 which is of special interest for the emergence and the explanation of the financial crisis. In addition the focus will be not only on the United States but also on European countries and China. The paper comes to the conclusion that the recipe of the famous post-war German minster for economics, Ludwig Erhard, “Wohlstand für alle” (material well-being for all) is supported by the recent evidence and that policies fostering a more equal distribution provide the best way out of the current crises. However, the wave of “structural reforms” that currently are implemented above all in the European “problem countries” weakens the bargaining power of trade unions and workers and tends to increase income inequality. This will make even more difficult for the world economy to find back to a path of sustainable growth.

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