Inequality, Leverage and Crises: The Case of Endogenous Default

49 Pages Posted: 9 Jan 2014

See all articles by Michael Kumhof

Michael Kumhof

Bank of England

Romain G. Rancière

University of Southern California

Pablo Winant

Bank of England

Date Written: December 2013

Abstract

The paper studies how high household leverage and crises can arise as a result of changes in the income distribution. Empirically, the periods 1920-1929 and 1983-2008 both exhibited a large increase in the income share of high-income households, a large increase in debtleverage of the remainder, and an eventual financial and real crisis. The paper presents a theoretical model where higher leverage and crises arise endogenously in response to a growing income share of high-income households. The model matches the profiles of theincome distribution, the debt-to-income ratio and crisis risk for the three decades prior to the Great Recession.

Keywords: Income distribution, Private sector, Credit demand, Debt, Financial crisis, Income inequality, wealth inequality, debt leverage, financial crises, wealth in utility, global solution methods., recession, crisis probability, consumption smoothing, consumption inequality, real interest rate, crisis probabilities, general equilibrium, consumption levels, household income, lifetime consumption, systemic risk, household income inequality, income growth, crisis episodes, consumer durables, consumption declines, credit boom, consumption volatility, lifetime income, credit booms, level of consumption, consumption constant, consumer expenditure survey, financial liberalization, distribution of income,

JEL Classification: E21, E25, E44, G01, J31

Suggested Citation

Kumhof, Michael and Rancière, Romain G. and Winant, Pablo, Inequality, Leverage and Crises: The Case of Endogenous Default (December 2013). IMF Working Paper No. 13/249. Available at SSRN: https://ssrn.com/abstract=2376683

Michael Kumhof (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Romain G. Rancière

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Pablo Winant

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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