Does Inequality Lead to a Financial Crisis? Revisited

Xinhua Gu and Bihong Huang

Review of Development Economics, 2014, vol. 18, issue 3, 502-516

Abstract: Financial crises have been attributed to rising income inequality via its induced high household leverage as observed in the USA and similar economies. Alternatively it has been suggested this is not a general relationship since it was found that inequality had no bearing on crises in 14 advanced countries over 1920–2008; instead, low interest rates and business cycle expansions are found to be the only two robust determinants of credit booms leading to crises. Using a similar dataset, this paper provides no support for the generality of the above findings by embracing country heterogeneity. The paper shows that real evidence still points back to the inequality-leverage–crisis nexus for financialized economies. The implication is that finance can hardly be sustainable under rising inequality.

Date: 2014
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