TECHNOLOGY AT WORK

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Citi GPS: Global Perspectives & Solutions February 2015
Macroeconomic Stability Risk
The surge in income inequality has been
accompanied by a sizeable increase in
borrowing, which has helped sustain
consumption levels
While real pay for most ordinary workers in the rich world has stagnated or even
fallen, economists have long understood that it is not income that matters but
consumption. Importantly, in America, the hollowing-out of middle-income jobs and
the surge in income inequality has been accompanied by sizeable increases in
borrowing, which has helped sustain consumption levels.
In his book Fault Lines: How Hidden Fractures Still Threaten the World Economy,
Raghuram Rajan argues that the credit expansion before the financial crisis of 2007
was the result of political pressures to maintain the consumption levels of the
increasingly squeezed middle. Thus, the underlying cause of the financial crisis was
the rise in inequality, encouraging the provision of easy credit to boost employment
despite stagnating incomes.
A recent IMF Working Paper similarly shows that the period leading up to the crisis
was characterised by high-income individuals saving more, and increased
borrowing among low-income workers, leading to lower consumption inequality
relative to income inequality. 108 The increase in saving and borrowing, in turn,
created a growing demand for financial services, intermediating borrowers and
lenders. The result can be seen in the ratio of banks’ liabilities to GDP, which
increased substantially. This build-up of household debt that culminated in the
financial crisis of 2007 was no doubt more costly than redistribution policies to
reduce the underlying problem: income inequality. From a macroeconomic
stabilisation point of view, policies to reduce inequality and excessive credit
expansion ex-ante would thus be preferable to ex post bailouts or debt
restructurings.
Although the recent surge in inequality may
not have been the sole cause of the financial
crisis, it is a risk to macroeconomic stability
However, an empirical association between income inequality and credit booms
does not necessarily imply causality: both inequality and credit expansion can occur
as a result of a third factor. Financial market liberalisation, for example, may have
increased the relative earnings of the financial sector, and has thus contributed to
growing income inequalities. To be sure, the recent surge of inequality may not have
been the sole cause of the financial crisis, but it is nevertheless a risk to
macroeconomic stability.
Secular Stagnation
As sophisticated algorithms and computer-controlled devices are likely to replace
mainly low-skilled workers, already growing income inequality is likely exacerbated.
At the same time, the capital share of income may increase even further, benefiting
those with a lower propensity to consume. The result: reduced spending in the
economy and permanently lower aggregate demand.
Growing inequality could lead to a period of
secular stagnation
As has been pointed out by Lawrence Summers, growing inequality could lead to a
period of secular stagnation. Yet growing inequality is not the only force that may
cause stagnation. The very nature of the digital economy itself could cause stagnant
or even falling growth rates.
The secular stagnation thesis was presented by Alvin Hansen during the Great
Depression. According to Hansen’s theory, a slowdown in population growth and
the rate of capital-absorbing innovation would cause net savings at full employment
to grow, and net investment to fall. This, in turn, would result in a savings glut and
slower growth caused by a decline in new investment opportunities.
108 Kumhof and Ranciere (2010).
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