Unequal = Indebted

The IMF find that rising inequality is a key driving force behind balance of payments problems and domestic instability in developed countries.

“what unites the experiences of the main deficit countries is a steep increase in income inequality over recent decades, as measured by the share of income going to the richest 5 percent of the country’s income distribution.

This increase in inequality has contributed to a deterioration in the richest countries’ aggregate savings-investment balances, as the poor and middle class borrowed from the rich and from foreign lenders. This, along with the other factors mentioned above, can fuel current account deficits.

Indeed, we find that as income shares of the top 5 percent increased between the early 1980s and the end of the millennium, current account balances worsened. For example, in the United Kingdom, an 8.7 percentage point increase in the income share of the richest 5 percent was accompanied by a deterioration in the current account–to-GDP ratio of 2.7 percentage points.”

“The top group derives satisfaction not only from consumption—there is only so much a person who “has it all” can consume—but also from accumulating wealth, including financial wealth, meaning loans to the bottom group. Part of the top group’s response to the hike in its income is therefore to increase loans to the bottom group. This allows the bottom group to continue consuming the economy’s output even though it is earning a significantly lower share of income. Consequently, credit supply from the top group and credit demand from the bottom group increase simultaneously. The probability of default by the bottom group is assumed to increase with the level of debt, which builds up over time, thereby leading to higher risk premiums.”