DP8179 Inequality, Leverage and Crises

Author(s): Michael Kumhof, Romain Rancière
Publication Date: January 2011
Keyword(s): Income inequality; wealth inequality; leverage; financial crises; wealth
JEL(s): E21, E25, E44, G01, J31
Programme Areas: International Macroeconomics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=8179

The paper studies how high leverage and crises can arise as a result of changes in the income distribution. Empirically, the periods 1920-1929 and 1983-2007 both exhibited a large increase in the income share of the rich, a large increase in leverage for the remainder, and an eventual financial and real crisis. The paper presents a theoretical model where these features arise endogenously as a result of a shift in bargaining powers over incomes. A financial crisis can reduce leverage if it is very large and not accompanied by a real contraction. But restoration of the lower income group’s bargaining power is more effective.