Finance and Inequality: A Tale of Two Tails

Alexander Ludwig, Alexander Monge-Naranjo, Ctirad Slavík and Faisal Sohail

No 2020-044, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We estimate the effects that the different financial deregulations in the U.S. have had on the country’s income distribution. We find that the different reforms have moved inequality in drastically different directions. On the one hand, during the late 1970s and early 1980s, the removal of intra- and inter-state branching restrictions and the elimination of state-varying rates ceilings decreased inequality, as they mostly enhanced the incomes of workers in the lower tail of the income distribution. On the other hand, the repeal of the Glass-Steagall Act in 1999 substantially increased inequality, as it mostly and by large amounts– increased the incomes of workers in the upper tail of the distribution. To explore the mechanisms underlying the different effects, we also examine the responses within and across individuals in different age groups, and compare finance vs non-finance workers. Our findings indicated that models based solely on capital skill complementarities (CSC) are insufficient because they would imply similar responses to all reforms. We construct a model that emphasize the endogenous changes in the heterogeneous access (and choices) of households’ financial products. The model naturally explains how the different deregulations impacted the opposite tails of the income distribution by capturing the changes in the financial markets available to households of different incomes and characteristics.

Pages: 63 pages
Date: 2020-10-30
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DOI: 10.20955/wp.2020.044

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