Abstract
We investigate the interplay between increasing inequality and consumer credit in a complex macroeconomic system with financially fragile heterogeneous households, firms and banks. Simulation results show that there are pros and cons of introducing consumer credit: on the one hand, for a certain time, it leads to lower unemployment through boosting aggregate demand; on the other hand, it accelerates the system tendency to the crisis. Since the increase of financial profits goes with a decline of households’ real wealth, a policy trade-off emerges.
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Notes
The dependent variable in all model specifications is the level of domestic credit to the private sector. Data are from the World Development Indicators database
This model has been extended by Kumhof et al. (2012) to include the foreign sector and analyze the interplay between rising inequality, financial instability and current account imbalances in an open economy.
For a comprehensive survey of research on the links between income inequality and the Great Recession, see Van Treeck and Sturn (2012).
According to a Marxian perspective, consumer credit and, in general, the expansion of finance can be considered as factors that may counteract, at least for a while, the tendency of the profit rate to fall, when the economy has reached the limit of its “material expansion” (Russo, 2014).
A possible extension of the analysis would include the testing of different allocation rules between sovereign bonds and private lending and the investigation of a different relationship between the government and the central bank: for instance, we could assume that the central bank is not allowed to buy government bonds on the primary market. This should be particularly relevant for analyzing the current evolution of economic and financial conditions in the Eurozone.
This is another assumption we could remove in a future work in which the whole mechanism of portfolio allocation for private agents (that is, households, firms and banks) and the operation of policy makers are better implemented.
The target leverage is the ratio between required credit and firm’s net worth (x = f) or household’s wealth (x = h)
Remember that the interest rate set by the bank b on the credit extended to household h at time t is computed according to Equation 4 based on the same procedure for both firms and households.
Net of the amount needed for new entrant firms and banks replacing defaulted ones, see next Subsection; the fraction of dividends obtained by household h is proportional to the household h’s wealth compared with overall households’ wealth.
Only applied on wealth exceeding a threshold that is a multiple of the average goods price.
The assumption that dividends only depend on investment needs may seem restrictive, for instance, because firms do not change the payout policy during a crisis. However, there is ample literature supporting the fact that the payout policy has been increasingly oriented to the maximization of the shareholder value and not so much to liquidity or solvency problems that can emerge during a crisis. This holds both for firms and banks. For instance, Lazonick and O’Sullivan (2000) show that non-financial corporations has been characterized by a shift from a retain and reinvest strategy to a downsize and distribute strategy. Moreover, over the decade 2001-2010, the corporations in the S&P 500 Index distributed the 40 % of their profits on cash dividends, but also another 54 % on stock buybacks (Lazonick, 2013). Finally, the literature highlights that even when the financial crisis started and the banking system suffered the depletion of common equity through losses, banks continued to pay dividends, in spite of widely anticipated credit losses, because high dividend payments signal to the market the soundness of the bank (see, for instance, Acharya et al., 2011 and Brogi, 2010).
In case private wealth is not enough, then government intervenes. (However, this never happens in the simulations we present in the paper.)
The evolution of public deficit (and debt) depends on the parameter setting. We choose parameter values such that the public deficit to gdp ratio oscillates around 3 % (in normal times). As a consequence, the public debt to gdp ratio, which initially increases, tends to stabilize after a while, such as when the growth of nominal gdp due to inflation is above the growth rate of public debt.
Cross-correlations are computed by averaging values across MC simulations for the period from t = 101 to t = 200, before the large crisis.
In particular, all the simulations with CC converge to a complete crash of the private economy: when approaching the end of the simulation period, the level of unemployment is always 70 % in the CC scenario because no more firms demand labor and only a fraction g = 0.3 of households are employed by the public sector; consequently, there is no more dispersion around the mean value of unemployment and the mean absolute deviation is zero.
In this figure, we consider only the period of time from t = 101 to t = 200, the stable phase before the crisis.
Consider that the model takes a quite long time before that a large crisis emerges. Moreover, we do not introduce any counter-tendency, such as a public intervention based on a large investment plan, an institutional change, technological innovation, and so on. In those cases the economy should recover and work for many other periods. This is what we will investigate in a future version of the model incorporating long-run factors.
Although the empirical evidence seems to be against this hypothesis, at least for the US. Indeed, Coibion et al. (2014) investigate whether borrowing patterns on the part of low-, middle-, and high-income households differed depending on local income inequality (where local refers to the geographical dimension, that is, the ZIP code). The authors maintain that local inequality is the most relevant metric for “keeping up with the Joneses”. On these bases, they find that banks channel more credit toward lower-income applicants in low-inequality regions than the high-inequality regions.
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Acknowledgments and compliance with ethical rules
We are very grateful to the participants at EMAEE2013 held at the SKEMA Business School, Sophia Antipolis, Nice (France), on June 10-12, 2013, for useful comments and suggestions. We are indebted to two anonymous referees for valuable comments and suggestions. The authors declare that they have no conflict of interest. The research does not involve human participants and/or animals.
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Russo, A., Riccetti, L. & Gallegati, M. Increasing inequality, consumer credit and financial fragility in an agent based macroeconomic model. J Evol Econ 26, 25–47 (2016). https://doi.org/10.1007/s00191-015-0410-z
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DOI: https://doi.org/10.1007/s00191-015-0410-z