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Inequality, credit expansion and financial crises

Perugini, Cristiano and Hölscher, Jens and Collie, Simon (2013): Inequality, credit expansion and financial crises.

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Abstract

In the three decades leading up to the financial crisis of 2008/09, income inequality rose across much of the developed world. This has led to a vigorous debate as to whether widening inequality was somehow to blame for the crisis. At the heart of this debate is the question of whether rising inequality leads to private sector credit booms, which are, in turn, widely accepted as a macroeconomic risk factor. Despite growing interest, empirical evidence on an inequality-fragility relationship is limited. That which does exist fails to tip the balance of evidence conclusively one way or the other. This research adds to this scarce body of evidence. Based on an econometric analysis of a panel of eighteen OECD countries covering the period 1970-2007, this study finds a statistically significant, positive relationship between income concentration and private sector indebtedness when controlling for conventional credit determinants. The implications of such a relationship are twofold. First, the view that the distribution of income is irrelevant to macroeconomic outcomes (implicit in mainstream economic thought) needs a second look. Second, if policy makers wish to make the financial system more robust, they should cast the net wider than regulatory and monetary policy reforms, and consider the effects of changes to the distribution income.

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