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Commentary :: Labor
IMF Working Paper: "Inequality, Leverage and Crises"
05 Feb 2011
"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."
"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 1983-2008 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...

The United States experienced two major economic crises over the past century—the Great
Depression starting in 1929 and the Great Recession starting in 2007. Both were preceded by
a sharp increase in income and wealth inequality, and by a similarly sharp increase in
debt-to-income ratios among lower- and middle-income households. When those
debt-to-income ratios started to be perceived as unsustainable, it became a trigger for the
crisis. In this paper, we first document these facts, and then present a dynamic stochastic
general equilibrium model in which a crisis driven by income inequality can arise
endogenously. The crisis is the ultimate result, after a period of decades, of a shock to the
relative bargaining powers over income of two groups of households, investors who account
for 5% of the population, and whose bargaining power increases, and workers who account
for 95% of the population."

to read the 38 page pdf IMF Working Paper "Inequality, Leverage and Crises" published in November 2010, click on
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