Income Inequality and Market Fragility: Some Empirics in the Political Economy of Finance
18 North Carolina Banking Law Journal (2013) (Forthcoming)
42 Pages Posted: 22 Jan 2013 Last revised: 15 Oct 2013
Date Written: January 21, 2013
A venerable line of thinking associated with 19th and early 20th century political economy suggests that income and wealth concentration are not only unjust in some circumstances, but also can operate as significant sources of systemic fragility in decentralized market economies. The guiding intuition is that relative losses below the top of the distribution can impede the clearing of consumer goods markets. That in turn deprives the macroeconomy of growth-underwriting consumer demand, thereby lowering employment and feeding back in to the goods-clearing problem itself. Such is the classical theory of feedback-fed “crisis.”
A subsequent line of thinking associated with the 20th century Keynesian and Kaleckian schools effectively identifies (a) the marginal propensity to consume’s inverse relation to wealth, and (b) the recursive structure of decentralized investment behavior as additional links in the political economists’ crisis dynamic. Factor (a) renders aggregate demand stability ever more investment-dependent, while factor (b) leaves investment markets prone to feedback dynamics and consequent underemployment equilibria of their own. Such is the Keynes-Kalecki account of inequality-induced or -exacerbated crash and depression.
In a modern market economy with a developed financial sector, one would expect the Keynes-Kalecki update of the political economists’ crisis dynamic to work through the medium of ever more sophisticated consumer- and mortgage-debt products and associated derivative contracts. These would respond to both heightened demand for investment yield at the top of the increasingly skewed distribution, and heightened borrowing needs below the top of the distribution. In such an economy one would also expect leverage-fueled asset price bubbles and busts and their Fisher-style debt-deflationary sequels to be larger and longer, respectively, than in times past, owing to mortgage debt’s tending to lengthen the leverage cycle.
Using autoregressive filtering, time-lagged cross-correlations, and cognate statistical methods on large sets of data that include income inequality, debt and investment trends, consumption and price indices, current account balances and other indicators of macroeconomic performance, we find strong support for the proposition that our “financialized” rendition of the Keynes-Kalecki-supplemented political economists’ crisis dynamic links significant income and wealth inequality to market fragility. This goes a long way toward explaining, among other things, a remarkably rich set of parallels that we find between the paired inequality and market calamity of 1928-29 on the one hand, and that of 2008-09 on the other hand.
Our results also bear implications for the project of financial regulation. While gathering income and wealth inequality do not render that project futile, they do seem, ironically, to render it simultaneously more urgent and more difficult.
Keywords: Inequality, Finance, Financial Crisis, Financial Markets, Macroeconomic Dysfunction, Market Fragility, Political Economy
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