Did Inequality Cause the U.S. Financial Crisis?

28 Pages Posted: 11 Jun 2014

See all articles by Till van Treeck

Till van Treeck

Hans-Boeckler-Stiftung - Macroeconomic Policy Institute (IMK)

Date Written: July 2014

Abstract

In his widely discussed book ‘Fault Lines’ (2010), Raghuram Rajan argues that many low and middle income consumers have reduced their saving and increased debt since income inequality started to soar in the United States in the early 1980s. This has temporarily kept private consumption and employment high, but it also contributed to the creation of a credit bubble. This surge in household indebtedness turned out to be unsustainable in the financial crisis starting in 2007. Although Rajan and others emphasize the role of government in promoting credit to those households with declining relative (permanent) incomes, other strands of the literature have focused more explicitly on the implications of rising inequality for aggregate demand and households’ demand for credit. These differences in emphasis may explain why the literature on the inequality‐crisis nexus appears somewhat disparate, even though the various strands are far from mutually exclusive but rather complement each other. We therefore place the ‘Rajan hypothesis’ in the context of competing theories of consumption, and survey the empirical literature on the effects of inequality on household behaviour. We conclude that the empirical evidence calls for a renaissance of the relative income hypothesis of consumption.

Keywords: Consumption theory, Great Recession, Household debt, Income inequality

Suggested Citation

van Treeck, Till, Did Inequality Cause the U.S. Financial Crisis? (July 2014). Journal of Economic Surveys, Vol. 28, Issue 3, pp. 421-448, 2014, Available at SSRN: https://ssrn.com/abstract=2448757 or http://dx.doi.org/10.1111/joes.12028

Till Van Treeck (Contact Author)

Hans-Boeckler-Stiftung - Macroeconomic Policy Institute (IMK) ( email )

Hans-Böckler-Straße 39
40476 Düsseldorf
Germany

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