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The Circular Relationship between Inequality, Leverage, and Financial Crises

Abstract : In this paper, we put into perspective the recent literature which points to inequality as a possible cause of credit bubbles, by reintegrating it into a more general analysis on the two-way relationship between inequality and finance. We focus more specifically on situations where high inequalities and widespread access to credit coexist, and argue that, even when institutions maintain more or less equal access to finance, there may be a dynamic, positive circular relationship between inequality and financial development. However, if we find robust evidence in the literature of a positive causal impact of inequality on credit, the conclusions concerning the distributional impact of financial development, financial deregulation, and financial crises become less clear. A survey of the empirical literature highlights several issues that must be tackled. First, endogeneity: reverse causality and coincidental factors are major concerns. Second, the choice of consistent measurements for the key variables (both credit and inequality) has strong empirical implications, and must be grounded on relevant theoretical channels. Third, those circular dynamics have substantial policy implications for emerging countries, since an increasing number face a joint increase in inequality and credit.
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https://halshs.archives-ouvertes.fr/halshs-01251360
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Submitted on : Wednesday, January 6, 2016 - 9:53:56 AM
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Rémi Bazillier, Jérôme Hericourt. The Circular Relationship between Inequality, Leverage, and Financial Crises. 2016. ⟨halshs-01251360⟩

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