We know three things about the US economy: the rich are getting richer, everyone is in debt, and interest rates have gone down. Is there a link? Yes, and the link has implications for fiscal and monetary policy.
By forcing interest rates down, extreme wealth inequality pushes the US economy into a “debt trap” that is difficult to escape with conventional macroeconomic tools, write Atif Mian of Princeton, Ludwig Straub of Harvard and Amir Sufi of the University of Chicago in a paper which came out earlier this year, titled “Debt Demand”. They advocate unconventional measures such as redistributive fiscal policies that narrow the gap between rich and poor.
The paper is in line with the work of former Federal Reserve Chairman Ben Bernanke, who publicized the concept of a global savings glut, and former Treasury Secretary Lawrence Summers, which revived the notion of secular stagnation during the Depression era. Mian, Straub and Sufi’s contribution is the Leverage Demand Theory, which they write as “the idea that a heavy debt burden lowers aggregate demand, and therefore the natural interest rate.”
Here’s their concept: the rich can’t spend all they earn, so they save a lot. In theory, this savings can be recycled into productive investment, but in practice, much of the money finances borrowing, that is, dissaving, by people lower in the income scale. “A substantial amount of borrowing by households in the bottom 90% of the wealth distribution has been financed by the accumulation of financial assets by the top 1%,” write the economists, citing their own previous work.
Lending from the rich to the poor can be indirect. For example, suppose a wealthy person purchases shares issued by a company. The company hides the product in a bank. The bank in turn gives a loan to a non-rich person to buy a car or a house. Borrowers have a higher propensity to spend than lenders, but they have less money to spend because part of their income goes to service debt.
The excess of the desired savings over the desired investment pushes interest rates down and down to the effective lower limit of around zero. Rates can’t go much below zero because savers don’t tolerate it – they’d rather put their money under a mattress than get negative returns.
Any policy that tries to fix things by encouraging more borrowing makes things better in the short term but worse in the long term by imposing even more debt on private or public borrowers that will eventually need to be repaid, write the economists.
This is why they favor redistribution through income or wealth tax, which would increase purchasing power by 90%. “One-off debt cancellation policies can also lift the economy out of the debt trap, but must be combined with other policies, such as macroprudential policies, to avoid a return to the debt trap over time. time, ”they write.
Not everyone agrees, of course. An article on research in the last issue of the Chicago Booth Review, a publication of the University of Chicago’s Booth School of Business, quotes Booth’s Steven Kaplan as saying that wealth taxation has been attempted unsuccessfully in Europe. Kaplan also told the publication that wealth inequalities declined before the pandemic hit.
The Chicago Sufi responds in the article: “Any decline in inequality from 2017 to 2019 was minimal compared to the rise in inequality since the 1980s, and the Covid-19 crisis will almost certainly amplify inequality in the future. . “