Jonathan Rauch - the guy who's concept of "demosclerosis" we read along with Fed 10 - argues that inequality suppresses demand, which inhibits growth, and leads to instability which can fuel financial crashes. Was the financial crisis which began 4 years ago caused by - and continues to linger because of - significant inequality between the rich and everyone else?
Worth looking through before we attempt economic policymaking. A brief bit:
As Christopher Brown, an economist at Arkansas State University, put it
in a pioneering 2004 paper, “Income inequality can exert a significant
drag on effective demand.” Looking back on the two decades before 1986,
Brown found that if the gap between rich and poor hadn’t grown wider,
consumption spending would have been almost 12 percent higher than it
actually was. That was a big enough number to have produced a noticeable
macroeconomic impact. Stiglitz, in his book, argues that an
inequality-driven shift away from consumption accounts for “the entire
shortfall in aggregate demand—and hence in the U.S. economy—today.”
. . . So inequality might suppress growth. It might also cause instability. In
a democracy, politicians and the public are unlikely to accept
depressed spending power if they can help it. They can try to compensate
by easing credit standards, effectively encouraging the non-rich to
sustain purchasing power by borrowing. They might, for example, create
policies allowing banks to write flimsy home mortgages and encouraging
consumers to seek them. Call this the “let them eat credit” strategy.
. . . You can see where the logic leads. The economy, propped up on shaky
credit, becomes more vulnerable to shocks. When a recession comes, the
economy takes a double hit as banks fail and credit-fueled consumer
spending collapses. That is not a bad description of what happened in
the 1920s and again during these past few years. “When—as appears to
have happened in the long run-up to both crises—the rich lend a large
part of their added income to the poor and middle class, and when income
inequality grows for several decades,” the IMF’s Michael Kumhof and
Romain Rancière wrote, “debt-to-income ratios increase sufficiently to
raise the risk of a major crisis.”
Andrew Sullivan comments here.
