Inequality and Macroeconomic Performance

Abstract

This paper argues that although the crisis may have emerged in the financial sector, its roots are much deeper and lie in a structural change in income distribution that has been going on for the past three decades. The widespread increase of inequality depressed aggregate demand and prompted monetary policy to react by maintaining a low level of interest rate which itself allowed private debt to increase beyond sustainable levels. On the other hand the search for high-return investment by those who benefited from the increase in inequalities led to the emergence of bubbles. Net wealth became overvalued, and high asset prices gave the false impression that high levels of debt were sustainable. The crisis revealed itself when the bubbles exploded, and net wealth returned to normal level. We further argue that how the trend of increasing inequality interacted differently with policies and institutions, to yield radically different outcomes in the US and in the large European Union countries before the onset of the crisis.Financial crisis, income inequality, US and EU comparison, household debt, aggregate demand