Blogs & Comment

Is inequality threatening the U.S. economy?

A Fed Governor wonders aloud.


We all know about income inequality: the gap between rich and poor has been widening since the late 1970s, middle class wages have been stagnating, and people in the top 1%—or rather the top 0.01%—of the income distribution owe most of their meteoric rise to riches precisely to eye-popping salaries. We know it’s not just America: the same trend is visible in most advanced economies, including Scandinavian countries. And we know there’s no one comprehensive and widely accepted explanation for why this happened.

At least in the U.S., though, studies on the recession are now starting to shine the light on another type of economic disparity that’s also been growing: wealth inequality. Not only did the vast majority Americans’ net-worth tumble during the recession, for 93% of households, it continued to slide during the first two years of the recovery as well, a recent study by the Pew Research Center found.

By the end of 2011 household wealth had regained virtually all the ground it lost since 2005 on average, but most Americans wouldn’t have known. While the richest eight million families, or 7% or all households, saw their wealth soar 28% from 2009 to 2011, the other 111 million, mean net-worth slid 4%.

Mostly, that’s because the richest households tend to hold most of their wealth in financial assets, whose value increased rapidly after the downturn, while poorer folks have a much larger share of their net-worth tied up in real estate, whose value didn’t bottom out until the end of 2011, Pew researchers note. Between June of 2009, when the U.S. recession formally ended, and the last quarter of 2011 the S&P 500 rose 34%, but the S&P/Case-Shiller home price index fell 5% (after losing 31% from peak to trough between 2006 and mid-2009).

Since Pew Research Center’s study doesn’t look past 2011, the last year the Census Bureau has data, it doesn’t capture the house price rebound of 2012. Still, the disparities it describes are startling, and they might have implications for the wider economy.

For example, did wealth inequality worsen the recession and weaken the recovery? Fed Governor Sarah Bloom Raskin has been wondering out loud for a while now, after looking at the same evidence considered by the Pew Research Center.

Truth be told, wealth inequality has traditionally been even more skewed than income inequality in the U.S., and hasn’t quite widened quite as much in the last four decades. But, in conjunction with stagnating wages and lax underwriting standards, it might have become an element of economic instability, Raskin suggested in a recent speech. The hypothesis that lower-middle income households with no prospects of meaningful wage gains might have viewed the housing boom as their only chance to improve their net-worth, seemed “quite plausible,” the governor said. It would explain why so many rushed to take on so much debt, even if their labour income was flat. Relaxed lending standards, in turn, allowed them to do so.

When the housing market’s wealth train hit a wall, of course, the consequences were disastrous. Even though wealthy households had been as ready as middle and low income ones to believe that house prices would only go up, when the crash hit, the wealthy had both much more of a cushion to soften the harsh landing and much less of their net-worth tied up in real estate. They suffered less and recovered faster. The rest of America was tied at the hip to the housing market. At the lower end of the income spectrum, in particular, households that went through foreclosure or had underwater mortgages were less able to take advantage of low interest rates, which curtailed the effect of the monetary policy stimulus, Raskin noted.

The governor was quick to note that research into whether inequality is affecting the business cycle is still in the early stages. However, she concluded, if more evidence will point that way, wealth and income disparities might make it onto the list of things the Fed looks at when trying to make sense of the U.S. economy and formulate its policy. Coming from a top official at the bank, that’s saying something.