Income inequality and the global crisis

Michael Kumhof, Deputy Division Chief, Modeling Unit, Research Department, IMF and Romain Rancière, Associate Professor of Economics at Paris School of Economics are apocalyptic regarding the origins of the financial crisis in a recent article (06/02/2011, VoxEU) and are fully supporting now the ideas and similar findings and forecasts of Costas Kataras as described in his latest book “Nice Capitalism” (2008). The two authors are saying that “ of the many origins of the global crisis, one that has received comparatively little attention is income inequality. This column provides a theoretical framework for understanding the connection between inequality, leverage and financial crises. It shows how rising inequality in a climate of rising consumption can lead poorer households to increase their leverage, thereby making a crisis more likely. The US has experienced two major economic crises during the last century – 1929 and 2008. There is an ongoing debate as to whether both crises share similar origins and features (Eichengreen and O’Rourke 2010). Reinhart and Rogoff (2009) provide and even broader comparison. One issue that has not attracted much attention is the impact of inequality on the likelihood of crises. In recent work (Kumhof and Ranciere 2010) we focus on two remarkable similarities between the two pre-crisis eras. Both were characterised by a sharp increase in income inequality, and by a similarly sharp increase in household debt leverage. We also propose a theoretical explanation for the linkage between income inequality, high and growing debt leverage, financial fragility, and ultimately financial crises”. “Nice Capitalism” is a truly prophetic book . You can now download for free here or to order from Amazon.