Income Inequality, Household Borrowing, and the Business Cycle

Abstract

Over the thirty years preceding 2008, the United States has experienced increasing income inequality while transitioning to a consumption-led economy. This dissertation investigates the foundations of the 2008 recession and offers an explanation for the slow growth recovery. Three distinct papers examine a different aspect of household borrowing and the way it can influence macro-dynamics. The first paper situates the 2008 financial crisis within the growing body of literature, referred to as the New History of Capitalism. The 2008 financial crisis resulted from many years of the Government-Sponsored Enterprises’, Fannie Mae and Freddie Mac, efforts to expand access to homeownership among low-income households. This paper situates the events following the 1992 Housing Act within the New History of Capitalism to argue that the financial crisis was a feature of capitalism rather than a malfunction. The dissertation uses Hyman Minsky’s argument that economic agents determine a level of external financing by considering their ability to meet future cash commitments as a theoretical framework. This paper considers these borrowing decisions' role in a slow-growth recovery. A multilevel model regressing household payment to income ratio on weeks looking for work distinguishes between high and low-income households’ decisions to make cash commitments. The model results suggest that, as low-income households experience joblessness, they reduce their level of cash commitments. This reduction in borrowing by low-income households contributed to the slow growth recovery. Household borrowing can influence macroeconomic trends in the same fashion that Minsky argued firm investment does. Low-income households reduce their cash commitments more than high-income households when experiencing periods of joblessness. A Stock Flow Consistent macro-model examines the influence of these decisions on the slow-growth recovery. Simulations show that an increase(decrease) in the households' desired margin of safety decreases(increases) total output. Simulations also show that the most effective stimulus method in response to an increase in the desired margin of safety is fiscal spending.