Do Financial Crises Increase Income Inequality?

• In Event: Globalization and Financial Markets

Abstract

This paper investigates the impact of economic crises on income inequality. Important evidence
has emerged that in the aftermath of crises politics becomes polarized and economists have
linked this to greater differences in income due to crises. The evidence however on whether
crises can be linked to divergent incomes is weak and plagued by i) the possibility of a reverse
effect going from great disparity in incomes to major economic crises; ii) the persistent nature of
income inequality; and iii) important measurement error in both the dependent and independent
variables. We use the longest time stretch of available data on crises and types of crises (Reinhart and Rogoff 2011) and income inequality (Solt 2009), as well as General Method of Moments and Error Correction Models to more credibly tackle the complex theoretical and empirical
relationship between crises and inequality. We find strong evidence that currency, banking,
inflation and debt crises increase inequality, particularly in the long run.

Authors

• Cristina Bodea, Michigan State University

• Christian Houle, Michigan State University

• Hyunwoo Kim, Michigan state university