How income inequality leads to financial crisis
One of the first posts in this blog featured a documentary from AlJazeera, about the financial crisis. The Economist blog Free Exchange posted an interesting article how income inequality can lead to the financial crisis.
Here is the summary:
Opening up of credit
In his book “Fault Lines” Raghuram Rajan outlines the evolution of the US financial crisis. As a result of growing income inequality, the working class fell further behind. To counterbalance the Congresses in the 1990s opened a flood of mortgage credit, reduced the capital requirements as well as expanded loan guarantees to cover bigger mortgages with lower downpayments. The economists Michael Kumhof and Romain Rancière from the IMF built even a model, how income inequality can systematically lead to financial crisis.Trickle down consumption
Marianne Bertrand and Adair Morse from the University of Chicago studied how the spending choices of the top 20% affect the bottom 80%. In their paper they find that the level of consumption of the rich households leads to more spending by the non-rich.
In summary, the combination of these two points mentioned above gives a good explanation how a bubble is created until it blasts. At the end, however with even more devastating effects for the less privileged, while leaving the top income households nearly uneffected.
