Must Hegelian Irony yet, Merlin's Debt, us thus manciple?
Or a bad Actuarial bet become our Revelation Principle?
Touman's infinite Empire of the Xiongnu
One whistling arrowhead for Modu
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
In 1983, the top 5 percent exhibited a debt-to-income ratio of just over 80 percent and the bottom 95 percent a ratio of just over 60 percent. Twenty five years later, the situation is dramatically reversed, with a ratio of 60 percent for the top 5 percent and almost 150 percent for the bottom 95 percent.
The key mechanism is that top earners, rather than using all of their increased income for higher consumption, use a large share of it to accumulate financial wealth in the form of loans to bottom earners.Notice, if inflationary bias exists, that 'top earners' may end up earning a negative real return. Wealth distribution becomes more equal if they persist in such behaviour.
By accumulating financial wealth, top earners allow bottom earners to limit the drop in their consumption, but the resulting large increase of bottom earners’ debt-to-income ratio generates financial fragility that eventually makes a financial crisis much more likely.Financial Wealth represents a Present Value on an income stream. If top earners lend money to bottom earners just for present consumption, then, unless bottom earners' real wages rises more rapidly than their debt service burden, the Net Present Value will be negative. Moreover, if real wages are rising, it is likely that Technology is improving. It would be better to invest in Technology than to engage in usury- more particularly to NINJA (no income, no job, no assets) creditors. If real wages are falling, then it is folly to lend to people who are barely solvent as it is.
The crisis is the result of an endogenous and rational default decision on the part of bottom earners, who trade off the benefits of relief from their growing debt load against output and utility costs associated with default. Lenders fully expect this behavior and price loans accordingly. The crisis is characterized by partial household debt defaults and an abrupt output contraction, a mechanism that is consistent with the results of Philippon and Midrigan (2011) and Gärtner (2013) for the Great Recession and the Great Depression, respectively. When a rational default occurs, it does provide relief to bottom earners. But because it is accompanied by a collapse in real activity that hits bottom earners especially hard, and because of higher post-crisis interest rates, the effect on their debt-to-income ratios is small, and debt quickly starts to increase again if income inequality remains unchanged.
In our model, the financial sector intermediates funds between the increasingly richer top fraction of the population and the increasingly more indebted bottom fraction of the population. As the flow of funds between the two groups increases, so does the size of the financial sector as measured by total assets or total liabilities over GDP.Since poor people, by definition, don't have infinite funds, they are going to default on their interest payments sooner or later- unless of course they aren't stupid and don't get into debt in the first place. If the economy features ubiquitous riskless assets with a real rate of return above the interest rate this process can run and run till all the stupid poor people have no assets and are sleeping in the streets and sullenly sucking off Bankers to avert starvation.
The real wage over the initial decade collapses by close to 6%, while the return to capital increases by over 2 percentage points. Workers’ consumption however declines by only around two thirds of the decline in wage income, as workers borrow the shortfall from investors, who have surplus funds to invest following their increase in bargaining power. Over the 30 years prior to the outbreak of the crisis, loans more than double to bring workers’ leverage, or debt-to-income ratio, from 64% to around 140%, with the crisis probability in year 30 exceeding 3%. The loan interest rate for most of this initial period is up to 2 percentage points above its initial value, as lenders arbitrage the return to lending with the now higher return to capital investment.Suppose you are a Capitalist and find the above model convincing. You should go in for Capital widening- i.e. increase production keeping the Capital to Labour output constant. There's no need for Capital deepening or automation or offshoring. So long as you are rich, you'll just keep getting richer by investing in employment generation. As a matter of principle, you may insist that workers sleep on the streets and suck off a Banker or two before showing up at work. That is a matter of personal taste.
restoration of poor and middle income households’ bargaining power can be very effective, leading to the prospect of a sustained reduction in leverage that should reduce the probability of a further crisis.