Inequality 2

What are the three possible consequences of inequality?

Financial Crisis’ and stability:

• The build up of debt on individuals and the vulnerability of a crisis

Housing market distortion:

• The areas of highly concentrated high income earners pushing up housing prices

Social and consumption spillover:

• How the spending behaviour of high income earners affects the lower income ones.

Research by Michael Kumhof suggests that the great depression and 08 financial crisis was caused by?

• Sharp increase in income inequality

• Rising debt to income ratios for lower to middle income households

These two go in pair because as inequality increases, high income earners gain more hence their living standards increase, while lower earners try to maintain so they borrow increasing debt.

What is financial fragility?

The state of vulnerability to financial shocks due to high debt and not having the capacity to absorb the shocks.

The debt to income ratio

Debt to income ratio = Total debt/Total income * 100

• the higher the ratio, the greater the financial fragility

Process of the study (Kumhof) of how financial crisis’ are more likely (argument):

• Income inequality rises and households are split into two groups, the top 5% where income shares increase and 95% where income shares decrease

• As income rises for the top 5%, they tend to not spend most of it on consumption, but on saving, hence creating lending for borrowers

• The 95% keep up their spending by borrowing (enabled by the 5%) which increases their debt to income ratio

• Hence financial fragility for each individual increases, when in collation, makes a crisis more likely to happen

There is a cycle where the top earners are able to accumulate assets and build wealth through lending to borrowers, who then increase their debt.

What are superstar cities and why are they in demand?

These are metropolitan areas where house prices have risen much stronger relative to other areas, containing high earners on average

They attract a certain demographic because of the particular amenities, lifestyle and job opportunities

Process of inequality exacerbating housing prices

• The key assumption is that supply of housing is inelastic meaning that supply cannot change much with high demand.

• So high income households increase and demand in these supercities for housing increases

• With the limited supply, and high demand, households outbid each other pushing the prices up

• hence those who don’t have the income to sustain are margined out leaving the highest earners

What is trickle down consumption?

The idea that high earners consumption patterns influence lower earners, meaning lower earners spend more of their income on consumption

• this is due to social consumption, hence lower earners spend more on visible goods and services, even if not essential.

• Importantly the study rules out any wealth effects or the permanent income hypothesis

What is the spillover effect of top income earners?

When income increases for top earners, so they then demand the higher quality services which in turn increases the demand and wages for those workers furthering income inequality