Wealth and income inequality exacerbate economic downturns, making stability even more elusive, study says. 

Author: Justin Keay
Dirk Krueger

Dirk Krueger, the University of Pennsylvania

Income and wealth inequality, which have widened a lot in the past 30 years in the US and elsewhere, make recessions more severe because poor people, who have little or no savings and often flawed credit, sharply reduce consumption when facing a sudden drop in income.

This is the conclusion of a recent study based on the Great Recession of 2007­–2009. It’s one of the first studies showing that income distribution is not only important for addressing economic equality, but that it also directly impacts the depths of economic troughs. The research, by economists Dirk Krueger of the University of Pennsylvania, Kurt Mitman of the University of Stockholm and Fabrizio Perri of the Federal Reserve Bank of Minneapolis, looks at US federal data to conclude that the Great Recession would have been half a percentage point less severe in a society with a more equal distribution of income and wealth—for example, the US of the 1960s.

 “What we found is that people at the lower end of the income distribution reacted more strongly to a given decline in their income,” Krueger tells Global Finance. “In an economy where there are more poor people with little wealth, economic fluctuations are larger because you have a larger share of the population responding more strongly to negative shocks.”

Still, some believe inequality is a motivating spice that boosts economic expansion. “A lot of economists believe that a certain degree of wealth inequality is important for the long-run growth prospects of an economy because inequality triggers remuneration of entrepreneurship,” Krueger notes, “but that is long-run growth.”              


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