ESSAYS ON INEQUALITY, HOUSEHOLD DEBT AND FINANCIAL INSTABILITY

My Ph.D. thesis contributes to the growing literature on the link between inequality and economic crises, focusing in particular on the relationship between rising income disparities, household debt dynamics and the resulting financial instability. In the first paper, I review both the theoretical and the empirical literature on inequality, by paying particular attention to the way this topic has been treated over time by the economics research agenda. I show that the impact of growing income disparities on the macroeconomy has been ignored for a long period of time, particularly starting from the 80s. Only after the recent financial crisis, the issue of income and wealth distribution has come back on the top of the agenda of economists as well as policymakers. In the other two papers, I build two macroeconomic models that focus on the link between income inequality, household debt and economic crises. The first one is an Agent-Based (AB) macroeconomic model aimed at describing the key mechanisms through which rising inequality jeopardises economic stability in an economy with peer effects in consumption and equity extraction processes. I show that greater income disparities imply stronger expenditure cascades along the income distribution as well as asset (i.e. house) price appreciation. In the presence of home-equity based borrowing behaviour by households, private debt rises thus pushing aggregate demand upwards despite income stagnation over much of the distribution. However, debt-driven consumption endogenously triggers the accumulation of a larger amount of non-performing loans on banks’ balance sheets which eventually lead to a credit crunch and an economic downturn. The second model, a joint work with Francesco Saraceno which I carried out during my visiting period at OFCE-SciencesPo in Paris, is a macroeconomic model with an Agent-Based household sector and a stock-flow consistent structure. The goal of this work is to analyse the impact of rising income inequality on the likelihood of a crisis under different institutional settings and degrees of financialisation. In particular, we reproduce a multitude of scenarios showing how financial and credit conditions interact with the impact of growing inequality on the performance of the economy and the accumulation of household debt. Our results show the relevance of the “degree” of financialisation of an economy. In fact, when inequality grows, a Scyilla and Charybdis kind of dilemma seems to arise: on the one hand, economies with low credit availability experience a drop in aggregate de- mand and output; on the other hand, where credit constraints are relaxed and the willingness to lend is higher, greater financial instability emerges and a debt-driven boom and bust cycle. We also show that policy reactions play a key role: a real structural reform that tackles inequality, by means of a more progressive tax system, actually compensates for the rise in income disparities thereby stabilising the economy. Results also show that this is a much better solution compared to a stronger fiscal policy reaction, which, instead, has no significant impact on the performance of the economy.