Income Inequality and Financial Crisis

The Great Recession of 2007-9, like the Great Depression in 1929-33, was triggered by a massive financial crisis: stock market crash, falling asset prices, bank failures, and liquidity crisis. One of the key triggers of instability in banking and the resulting financial crises is what economists call “over-leverage”, meaning too much (private) credit and too much (private) borrowing relative to incomes. When the crisis hits, people start to “de-leverage”, that is pay-off debts and/or write-them-off in bankruptcy.  The process of de-leveraging forces people to use more of their incomes to pay off debt and less on spending. The decline in spending causes a decline in GDP, leading to layoffs, and a downward spiral.

Many of us have been intuitively saying that this over-leveraging (over-borrowing and going into debt) is the result of rising income inequality. Now Michael Kumhoff and Romaine Ranciere have published a study and a formal model to explain how such a process works. They note:

Of the many origins of the global crisis, one that has received comparatively little attention is income inequality. This column provides a theoretical framework for understanding the connection between inequality, leverage and financial crises. It shows how rising inequality in a climate of rising consumption can lead poorer households to increase their leverage, thereby making a crisis more likely.

They further show the similarities between 1929 and 2008.  It’s striking. As income inequality increases, i.e. the rich get richer faster, the rest have to go further into debt to maintain lifestyle or lifestyle progress. Overall debt and leverage rises until a crisis happens and the crash begins.

Figure 1 plots the evolution of the share of total income commanded by the top 5% of households (ranked by income) against household debt to GNP or GDP ratios in the two decades preceding 1929 and 2008. The income share of the top 5% increased from 24% in 1920 to 34% in 1928, and from 22% in 1983 to 34% in 2007. During the same two periods, the ratio of household debt to GNP or to GDP increased dramatically. It almost doubled between 1920 and 1932, and also between 1983 and 2008, when it reached much higher levels than in 1932.

Figure 1. Income Inequality and Household Leverage


Excerpt is copyright by, at Inequality, leverage and crises by Michael Kumhof Romain Rancière

Working America and Income Inequality

I just discovered a tremendous research source for students (and anybody else) who are curious about changes in income inequality, growth, health, education, etc. in America over a 90+ year period.  It’s very flexible and interactive with graphs, etc.   It’s The State of Working America, published by Economic Policy Institute. It has tremendous library of both static graphs from up-to-date data, but also some Flash-based interactive graphs such as the following on how income growth has been shared in the U.S. since 1917.  This is just a screen shot here, but you should definitely go to the site itself and play with it at

Screen shot of Income Growth at State of Working America Site

The best part is it is entirely Creative Commons licensed, so people can feel free to save copies of the images and re-use them without violating copyright (just remember to give credit to EPI and State of Working America).

This is a very, very useful site.  It’s on par with Hans Rosling’s, and that’s very high praise indeed.

Who Says Keynesian Policy Doesn’t Work?

It’s become fashionable, particularly among Republicans and Conservatives, to claim that Keynesian Policy doesn’t work despite the empirical record. Methinks they don’t know what Keynesian policies are analyses really are. Mark Thoma points out:

Issa: Everyone Knows That the Policies I Called for Don’t Work

Republican House member Darrell Issa has an op-ed in the Financial Times complaining that the stimulus did not stimulate (contrary to research such as this that finds “programs to support low-income households were highly stimulative, as was spending on infrastructure projects”). He says:

The abysmal results came as no surprise to those who knew that the Keynesian doctrine of spending your way to prosperity had been discredited decades ago.

Than it must of surprised him or, as is more likely, he doesn’t actually know what Keynesian economics is. This is what he said around the time when the stimulus package was put in place. His complaint is that the stimulus package doesn’t come online quickly enough, and doesn’t do enough for infrastructure (he also complains that the tax cuts aren’t permanent):

Economic Stimulus: There is bipartisan agreement for emergency spending on infrastructure and tax cuts that will create new jobs and reinvigorate private sector investments. Unfortunately, H.R. 1, the “American Recovery and Reinvestment Act of 2009,” falls short on both fronts. …

To respond to an emergency, you must act quickly. According to the Congressional Budget Office, only 7 percent of the $355 billion in discretionary spending included in the bill would be injected into the economy by the end of fiscal year 2009. By the end of 2010, only 12 percent of the funds set aside for highway construction will be spent.

Stimulus funds must be targeted to be effective. Only 3 percent of the $825 billion will go toward road and highway construction that creates jobs and aids individuals and private businesses alike. …

This bill will grow the government and miss an opportunity to reinvigorate the economy. An effective stimulus can be accomplished through tax cuts and targeted spending…

Targeted spending and tax cuts are effective stimulus, and he supports them, but we’ve known for decades that such Keynesian remedies don’t work? The mystery of the GOP’s credibility on economics continues…

As an note to the readers:  the economic success of Ronald Reagan’s policies in 1983-1988, following the horrible recession of 1982, are actually better explained and better fit a Keynesian analysis than a the predictions of so-called supply-side models and definitely better than New Classical models.  Reagan was really Keynesian, he just didn’t want to admit it and he preferred military spending and tax cuts for the upper income brackets to social spending.

30,000 Pigs?

Department of “Don’t believe everything you see in the newspaper”:

“More than 30,000 pigs have been floating down the Dawson River since last weekend, with a piggery at Baralaba paralysed by flooding which has killed most of its bred live-stock. Baralaba Butchers’ Sid Everingham … said: ‘We’ve lost probably about 30,000 pigs in the floods ….’” So reported the Rockhampton (Queensland) Morning Bulletin, with a headline to match (“More than 30,000 pigs lost in floodwaters”).

But a few days later, the newspaper published a correction:

What Baralaba piggery-owner Sid Everingham actually said was “30 sows and pigs”, not “30,000 pigs.”

Thanks to Ben Zimmer (Language Log) for the pointer. The Media Blog adds:

It is a little surprising that the reporter didn’t think to check. “Crikey, that’s a lot of a pigs mate, are you sure you mean 30,000?”. Similarly, if they really thought there were 30,000 pigs floating down the river, why did they only put it on page 11? That would be Biblical!