Does Class Inequality Cause Bubbles?

Econobloggers puzzle over the effects of a widening gap between the rich and poor

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The connection between class inequality and asset price bubbles is well established. That is, the gap between the very rich and everyone else tends to widen around the same time that over-investment causes a bubble. But why is that? Bloggers offer theories on the connections between class and the economy.

  • Rich Over-Investment, Poor Over-Borrow Econoblogger Steve Randy Waldman suggests the rich and poor spend differently. The super-rich over-invest, while the poor over-borrow, both to the greater detriment. "Whether an economy generates asset price inflation or consumer price inflation depends on the details of to whom cash flows. In particular, cash flows to the relatively wealthy lead to asset price inflation, while cash-flows to the relatively poor lead to consumer price inflation," he writes. "Except when the world seems very risky, no one holds cash for very long. Poorer people disproportionately use their cash to purchase goods, while richer people disproportionately 'save' by purchasing financial assets. If the supply of both goods and financial assets is not perfectly elastic, then increases in demand will be associated with increases in price. If relative demand for goods and financial assets is a function of the distribution of cash, what price changes occur will be a function of who gets what." Waldman concludes, "We need to build a system where changes in asset prices reflect the quality of real economic decisions, and where the playing field isn't tilted against the poor and disorganized in the name of promoting price stability."
  • Class Divisions Force Financial Irresponsibility Mother Jones's Kevin Drum points out that a system with wide class divisions forces individual actors, rich or poor, to behave in ways that harm the overall economy. "Rich people tend to do really stupid things when they have too much money lying around for too long. So do poor people, of course, but in their case 'too much money' is only enough to buy a bigger TV, not enough to blow up the world. That's why I think getting a handle on rising income inequality is important. To paraphrase William F. Buckley, if I had an extra million dollars to divvy up, I'd rather give it to the first thousand names in the New York City phone book than to the CEO of Goldman Sachs."
  • OK, But How Do We Fix This? The Economist's Ryan Avent puzzles over how economic policy can stop this trend. "I last discussed this in the context of a post noting that central bankers seemed to be coming around to [White House economic adviser Larry] Summers' view of things--that low inflation and interest rates were enabling damaging bubbles and financial crises," he writes. "But if this is more about to which groups the economic gains of growth accrue, then the appropriate Fed response is more difficult to imagine. Is it correct to say that by limiting the return to financial activities, investment will flow to productive ends, thereby reducing income inequality?"
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