Inequality, credit and financial crises

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 by driving private sector credit booms. Despite growing interest, empirical evidence on an inequality-fragility relationship is limited. Based on a panel analysis of 18 OECD (Organisation for Economic Co-operation and Development) countries for the years 1970-2007, this study provides evidence of a positive relationship between income concentration and private sector indebtedness, once other traditional drivers are controlled for. If confirmed, the implications of this result are as follows: (i) the view that the distribution of income is irrelevant to macroeconomic stability, as implicit in mainstream approaches, needs further investigation; and (ii) in order to make the financial system more robust, policy makers should cast the net wider than monetary policy and regulatory reforms and consider the effects of changes to distributive patterns.