DP8179 | Inequality, Leverage and Crises

Publication Date

03/01/2011

JEL Code(s)

Keyword(s)

Programme Area(s)

Network(s)

Abstract

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.