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Inequality, leverage and crises: Theory and evidence revisited

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  • Xinhua Gu
  • Pui Sun Tam
  • Yang Zhang
  • Chun Kwok Lei

Abstract

Rajan points to rising income inequality as a root cause of the recent financial crisis through high household leverage. The Rajan hypothesis has ignited debate over the relationship between inequality, leverage and crises. Kumhof, Ranciere, and Winant prove the validity of this hypothesis with a theoretical formulation, but empirical studies provide mixed evidence using different samples and estimators. To clarify this controversy, we re‐examine the issue by using the same data as in the literature and provide additional evidence after taking into account the role of asset bubbles and policy interventions. Our regression is based on a new tractable theoretical model that is supported by key stylised facts, and all our analyses confirm the existence of the inequality–leverage–crisis nexus.

Suggested Citation

  • Xinhua Gu & Pui Sun Tam & Yang Zhang & Chun Kwok Lei, 2019. "Inequality, leverage and crises: Theory and evidence revisited," The World Economy, Wiley Blackwell, vol. 42(8), pages 2280-2299, August.
    • Handle: RePEc:bla:worlde:v:42:y:2019:i:8:p:2280-2299
    DOI: 10.1111/twec.12806
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    Cited by:

    1. Bazillier, Rémi & Héricourt, Jérôme & Ligonnière, Samuel, 2021. "Structure of income inequality and household leverage: Cross-country causal evidence," European Economic Review, Elsevier, vol. 132(C).
    2. Xinhua Gu & Chun Kwok Lei & Qingbin Zhao & Nian Liu, 2024. "Different experiences of Asian emerging‐market economies in the two major financial crises," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 29(3), pages 3286-3308, July.
    3. Boris Cota & Nataša Erjavec & Saša Jakšić, 2024. "Income inequality, economic openness and current account imbalances in new EU member states," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 51(2), pages 403-423, May.
    4. Bazillier, Rémi & Héricourt, Jérôme & Ligonnière, Samuel, 2021. "Structure of income inequality and household leverage: Cross-country causal evidence," European Economic Review, Elsevier, vol. 132(C).

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