Sarah Bloom Raskin: Aspects of inequality in the recent business cycle
Speech by Ms Sarah Bloom Raskin, Member of the Board of Governors of the Federal
Reserve System, at the "Building a financial structure for a more stable and equitable
economy" 22nd Annual Hyman P. Minsky Conference on the state of the US and world
economies, New York City, 18 April 2013.
* * *
Thank you for asking me to join you today at this conference and to be a part of your
continuing inquiry into how the ideas and legacy of Hyman Minsky can inform and shape our
understanding of financial markets and the economy.
This speech expands on remarks I made in March to the National Community Reinvestment
Coalition, in which I explored the roles that monetary and bank regulatory policy play in
reducing the unemployment, economic marginalization, and financial vulnerability of millions
of moderate- and low-income working Americans. Today I am interested in continuing this
exploration by examining an issue of growing saliency that macroeconomic models used at
central banks and by academics have not traditionally emphasized - specifically, how such
economic marginalization and financial vulnerability, associated with stagnant wages and
rising inequality, contributed to the run-up to the financial crisis and how such marginalization
and vulnerability could be relevant in the current recovery.
To isolate my proper subject here, I want to be clear that I am not engaging this afternoon
with the concern that many Americans have that excessive inequality undermines American
ideals and values. Nor will I be investigating the social costs associated with wide
distributions of income and wealth. Rather, I want to zero in on the question of whether
inequality itself is undermining our country's economic strength according to available
macroeconomic indicators.
Economists have documented that widening income and wealth inequality has been one of
the most notable structural changes to the U.S. economy since the late 1970s. This change
represents a dramatic departure from the three decades prior to that time, when Americans
enjoyed broadly rising incomes and shared prosperity. Indeed, many of you in the room have
shed important light on the recent trends in inequality and on the potential role of fiscal policy
in addressing them. You have also explored how these trends are relevant to issues of
financial stability. I won't attempt to repeat this strong line of research and analysis. Instead,
my remarks today are specifically focused on adding to the conversation about how such
disparities in income and wealth could be relevant for a macro understanding of the financial
crisis and the recovery and the appropriate course of monetary policy today.
I will argue that at the start of this recession, an unusually large number of low- and
middleincome households were vulnerable to exactly the types of shocks that sparked the financial
crisis. These households, which had endured 30 years of very sluggish real-wage growth,
held an unusually large share of their wealth in housing, much of it financed with debt. As a
result, over time, their exposure to house prices had increased dramatically. Thus, as in past
recessions, suffering in the Great Recession - though widespread - was most painful and
most perilous for low- and middle-income households, which were also more likely to be
affected by job loss and had little wealth to fall back on.
Moreover, I am persuaded that because of how hard these lower- and middle-income
households were hit, the recession was worse and the recovery has been weaker. The
recovery has also been hampered by a continuation of longer-term trends that have reduced
employment prospects for those at the lower end of the income distribution and produced
weak wage growth.
Of course, it is not part of the Federal Reserve's mandate to address inequality directly, but I
want to explore these issues today because the answers may have implications for the
Federal Reserve's efforts to understand the recession and conduct policy in a way that
contributes to a stronger pace of recovery. Traditionally, the distribution of wealth and income
has not been a primary consideration in the way most macroeconomists think about business
cycles. But if inequality played a role in the financial crisis, if it contributed to the severity of
the recession, and if its effects create a lingering economic headwind today, then perhaps
our thinking, and our macroeconomic models, should be adjusted.
Despite the tentative nature of these conclusions, I do think it is vital to explore these issues,
and, in the spirit of Minsky, I hope my remarks spur more inquiry and discussion. I should
also note that the views I express are my own and not necessarily those of my colleagues on
the Board of Governors or the Federal Open Market Committee (FOMC).
Trends in income, wealth, and debt
In order to "level set" our understanding, let me begin by reviewing some of the changes to
the structure of income, wealth, and debt in the years leading up to the Great Recession -
changes that have had significant implications for the well-being of most American
households. Long before the recession - decades before, in fact - income data show only
sluggish increases in real incomes for low- and middle-income American households, and
more-rapid increases for high-income households, resulting in a much greater concentration
of income among those at the very top of the income distribution. As just one example of the
broader trend, according to the Congressional Budget Office, between 1979 and 2007,
inflation-adjusted, pretax income for a household in the top 1 percent more than doubled,
while, in contrast, income for a household in the middle of the income distribution increased
less than 20 percent.1 Over these years, the share of pretax income accruing to the top 1
percent of households also doubled, from 10 percent to 20 percent, while the share accruing
to the bottom 40 percent fell from 13 percent to 10 percent. These growing disparities of total
income are largely due to the increasing concentration of labor income, which, on average,
accounted for more than 70 percent of all income over this period. In addition, the distribution
of other sources of total income - such as profits from small businesses, capital gains and
dividend income, rental income, and the like - also became more concentrated over this
period.
Many have argued that these disparities in income are hindering economic growth through
their effects on consumption. Intuitively, one might assume that the growing concentration of
income at the top could lead to less consumer spending and aggregate demand, as wealthier
households tend to save more of their additional income than others. However, there is no
definitive research indicating that these income disparities show mixed results on the
question of whether there are stable differences in the marginal propensity to consume
across households with different incomes.2 More generally, the evidence is equivocal as to
whether there is an empirical relationship between higher income inequality and reduced
aggregate demand. In my view, understanding the links between greater concentrations of
income, variation in spending patterns throughout the income distribution, and the effect of
that variation on aggregate consumption - and, ultimately, growth - requires more
exploration.3
But since household behavior is surely driven by more than the size of the paycheck coming
in the proverbial front door, the distribution of wealth - as distinct from the distribution of
income - could have clearer implications for the macroeconomy. Indeed, wealth inequality is
greater than income inequality in the United States, although it has widened little in recent
decades. For example, according to the Survey of Consumer Finances (SCF), a survey
conducted every three years by the Federal Reserve Board, the top one-fifth of families
ranked by income owned 72 percent of the total wealth in the economy in 2010, whereas
families in the bottom one-fifth of the income distribution together owned only 3 percent of
total wealth in 2010.4
Hence, families with more-modest incomes have much less wealth to cushion themselves
against income shocks, such as unemployment. For example, in 2010, the median value of
financial assets was less than $1,000 for families in the lowest income quintile. Moreover,
what wealth low- and middle-income families do have is typically concentrated in housing.
For families in the top quintile of income, the value of residential properties accounted for
about 15 percent of total wealth in 2010. For families in the middle and lower half of the
income distribution, the ratio of their home values to total net worth was near 70 percent. In
contrast, stock market wealth (and the value of other securities) constitutes a very small
share of wealth for low- and middle-income families.
Because the wealth of people at the lower end of the distribution is concentrated in housing,
these households are disproportionately exposed to swings in house prices. This
compositional effect was intensified during the housing boom, as the share of wealth
accounted for by housing grew even faster for low- and middle-income families than for
highincome families. That said, the increases in homeownership and house values during the
rising
boom were largely financed by rising mortgage debt. Thus, the direct positive effect of
house prices on most households' net worth was largely offset by the negative effect of
increased debt that households took on. On net, mortgage debt and home values moved up
together. But when house prices began falling, the mortgage debt and repayment obligations
remained.
To be sure, the increase in mortgage debt prior to the recession occurred across all types of
households. But it was families with modest incomes and wealth largely in their homes that
were the most vulnerable to subsequent drops in home values.
3
One concern with rising inequality and stagnating wages is that low- and middle-income households will turn
to credit and wealth extraction to maintain their consumption growth. One sign of this behavior would be
consumption inequality rising much less than income inequality. Researchers - including Krueger and Perri
(2006); Aguiar and Bils (2011); and Attanasio, Hurst, and Pistaferri (2012) - have produced mixed findings on
this basic question, although, taken together, there is growing evidence that consumption inequality has also
risen substantially over the past several decades. See Dirk Krueger and Fabrizio Perri (2006), "Does Income
Inequality Lead to Consumption Inequality? Evidence and Theory," Review of Economic Studies, vol. 73
(January), pp. 163-93; Mark A. Aguiar and Mark Bils (2011), "Has Consumption Inequality Mirrored Income
Inequality?" NBER Working Paper Series 16807 (Cambridge, Mass.: National Bureau of Economic Research,
February); and Orazio Attanasio, Erik Hurst, and Luigi Pistaferri (2012), "The Evolution of Income,
Consumption, and Leisure Inequality in the US, 1980-2010," NBER Working Paper Series 17982 (Cambridge,
Mass.: National Bureau of Economic Research, April).
4
The specific measure used to group families for these wealth calculations is the stable component of income,
referred to in the SCF as "normal" or "usual" income. In the SCF, after families have reported their actual
incomes for the year, they are asked whether this was a normal year. If the answer is no, they are asked what
their income usually would be in a normal year. Using normal income as a classifier removes the systematic
bias in average wealth that arises when, for example, normally high-income families are temporarily in the
lowest income group because they had a particularly bad year.
The question then arises as to why households with poor income prospects sought out levels
of mortgage debt that would ultimately prove so problematic. Putting aside the practice, in
the run-up to the crisis, of lenders steering households to mortgage debt products that were
more costly than what such households may have otherwise qualified for, one reason may
have been that many households in the middle and lower end of the income distribution,
whose wage earnings were stagnant, did not recognize the long-run and persistent trends
underlying their lack of income growth.5 If households thought they were merely going
through a rough patch, it would have been quite reasonable for them to borrow money to
smooth through it - to make home improvements, for example, or to send a child to college.6
At the same time, many people believed that the sharp increases in their home values had
made them permanently richer and that house prices would never turn down, a belief that
appears to have been shared by many households in the upper part of the income
distribution as well. In fact, purchasing a house using debt was a profitable investment in the
early 2000s. While it is hard to know with any certainty what these individual households
believed at the time, it seems quite plausible to me, as others have argued, that stagnant
wages and rising inequality, in combination with the relaxation of underwriting standards, led
to an increase in the use of credit unsupported by greater income.7
Inequality and the Great Recession
Given these developments, when house prices fell, household finances were struck a
devastating blow. The resulting fallout magnified this initial shock, ushering in the Great
Recession. Let me lay out this argument in more detail.
As I mentioned earlier, low- to middle-income families held a disproportionate share of their
assets in housing prior to the financial crisis and hence were very exposed to what was a
historic decline in house prices. And so, while total household net worth fell 15 percent in real
terms between 2007 and 2010, median net worth fell almost 40 percent. This difference
reflects the amplified effect that housing had on wealth changes in the middle of the wealth
distribution.
5
In a separate line of inquiry on the social dynamics of spending, Bertrand and Morse (2013) find that
moderate-income households spend more if they live in states with rapid spending growth among high-income
households, which suggests another channel for inequality to increase debt. See Marianne Bertrand and Adair
Morse (2013), "Trickle-Down Consumption," NBER Working Paper Series 18883 (Cambridge, Mass.: National
Bureau of Economic Research, March).
6
In fact, recent research shows that these trends in annual inequality are mostly due to rising disparities in the
component of a household's income that is stable over time, rather than rising disparities in the component
that varies from year to year. See Jason DeBacker, Bradley Heim, Vasia Panousi, and Ivan Vidangos (2011),
"Rising Inequality: Transitory or Permanent? New Evidence from a U.S. Panel of Household Income
19872006," Finance and Economics Discussion Series 2011-60 (Washington: Board of Governors of the Federal
Reserve System, December).
7
For example, Rajan (2010) has argued that rising inequality resulted in the relaxation of credit standards,
which led to the financial crisis, and Kumhof and Ranciere (2011) present a model with such features.
However, Bordo and Meissner (2012) look at data from 14 advanced countries and do not find a general
relationship between inequality and credit booms. Meanwhile, Bhutta (2011, 2012) finds that federal programs
aimed at increasing homeownership only modestly increased the availability of mortgage credit to
Fault Lines: How Hidden Fractures Still Threaten the World
lowerincome borrowers. See Raghuram Rajan (2010),
Economy (Princeton, N.J.: Princeton University Press); Michael Kumhof and Romain Ranciere (2011),
"Inequality, Leverage and Crises," CEPR Discussion Paper 8179 (London: Centre for Economic Policy
Research, January); Michael D. Bordo and Christopher M. Meissner (2012), "Does Inequality Lead to a
Financial Crisis?" NBER Working Paper Series 17896 (Cambridge, Mass.: National Bureau of Economic
Research, March); Neil Bhutta (2011), "The Community Reinvestment Act and Mortgage Lending to Lower
Income Borrowers and Neighborhoods," Journal of Law and Economics, vol. 54 (November), pp. 953-83; and
Neil Bhutta (2012), "GSE Activity and Mortgage Supply in Lower-Income and Minority Neighborhoods: The
Effect of the Affordable Housing Goals," Journal of Real Estate Finance and Economics, vol. 45 (June),
pp. 238-61.
The unexpected drop in house prices on its own reduced both households' wealth and their
access to credit, likely leading them to pull back their spending. In particular, underwater
borrowers and heavily indebted households were left with little collateral, which limited their
access to additional credit and their ability to refinance at lower interest rates. Indeed, some
studies have shown that spending has declined more for indebted households.8
Compounding the effect of falling house prices on household wealth and credit was the fact
that these low- to middle-income households are also composed of some of the groups that
have historically borne the brunt of downturns in the labor market. During recessions, the
young, the less educated, and minorities are more likely to experience flat or declining
wages, reduced hours, and unemployment.9 While this disparity is not a new phenomenon,
dealing with a loss in labor income during the most recent recession was a heightened
challenge to households that had mortgage obligations and no other forms of wealth to
cushion the blow. The adverse developments in the labor market added to the difficulty most
households were having in repaying their existing debts and in accessing credit in the
recession.
These low- to middle-income households that bore the strains in both housing and labor
markets, and had little wealth cushion, had more difficulty making payments on their
mortgages and other consumer credit debt. For example, among the mortgages originated
from 2004 to 2008, almost 25 percent of those in low-income neighborhoods were foreclosed
on or in serious delinquency as of 2011, more than twice the rate of mortgages originated in
higher-income neighborhoods. Higher-income households had also taken on debt and were
affected by declines in asset prices. But these households entered the recession with a
larger wealth buffer and higher incomes, so they generally were still able to service their
debts. The sharp rise in defaults and delinquencies put extraordinary stress on most
households' finances, intensified the financial crisis, and exacerbated the effect of the initial
economic shocks. Indeed, a rapid downward spiral of tighter credit, declines in asset prices,
rising unemployment, and falling demand caused severe distress and a pullback in spending
that was ultimately widespread across households.
Inequality and the recovery
I have argued that rising inequality and stagnating wages may have led households to
borrow more and to pin their hopes for economic advancement on rising home values,
developments that exacerbated the severity of the financial crisis and recession. Now we are
nearly four years into the recovery, which has been weak. In my view, this same confluence
of factors has also contributed to the tepid recovery.
If my theory about why households overextended themselves before the financial crisis is
correct, then it is likely also true that households have had a rude awakening in the years
since. Not only did they receive an unwelcome shock to their net current wealth, but they
also undoubtedly have come to realize that house prices will not rise indefinitely and that
their labor income prospects are less rosy than they had believed. As a result, they are
curtailing their spending in an effort to rebuild their nest eggs and may also be trimming their
budgets in order to bring their debt levels into alignment with their new economic realities. In
this case, the effects of the plunge in net wealth and the jump in unemployment on
subsequent spending have been long lasting and lingering.
Overall debt levels remain higher than before the house price boom, and many families
continue to struggle to keep up with their monthly payments. Although many households
have significantly reduced their debt levels, many others probably have far to go.10 It is hard
to know just what the optimal debt-to-income ratio is, but, in my view, households will likely
aim for something lower than before the financial crisis: Households are probably working
toward lower, more-manageable debt service obligations; the heightened uncertainty in the
recession may have raised the desired level of financial buffers; and, to the extent that
households saw the negative shocks to house prices and income as permanent, they are
reducing their spending and thus their demand for new borrowing. While the process of
household deleveraging has affected the spending and borrowing of many households, there
is no doubt that the process has been more acute for those that have experienced
unemployment, underemployment, or slower wage gains.
To make matters worse, there is also some evidence to suggest that the factors that
contributed to the rise in inequality and the stagnation of wages in the bottom half of the
income distribution, such as technological change that favors those with a college education
and globalization, are still at play in the recovery - and perhaps may have accelerated.11
About two-thirds of all job losses in the recession were in middle-wage occupations - such
as manufacturing, skilled construction, and office administration jobs - but these occupations
have accounted for less than one-fourth of subsequent job growth.12 In contrast, the decline
in lower-wage occupations - such as retail sales, food service, and other lower-paying
service jobs - accounted for only one-fifth of job loss and more than one-half of total job
gains in the recovery.13
It is not only the occupational and industrial distribution of the new jobs that poses challenges
for workers and their families struggling to make ends meet, but also the fact that many of
the jobs that have returned are part time or make use of temporary arrangements popularly
known as contingent work. The flexibility of these jobs may be beneficial for workers who
want or need time to address their family needs. However, workers in these jobs often
receive less pay and fewer benefits than traditional full-time or "permanent" workers, are
much less likely to benefit from the protections of labor and employment laws, and often
have no real pathway to upward mobility in the workplace.14
10
In contrast to the decrease in overall debt, student loans have continued to rise at a solid pace. The
outstanding level of student loan balances is nearly twice its level five years ago and now represents the
largest component of consumer (nonmortgage) lending. The increase in student loans is likely related to
broader developments in the recession and exposes the households holding these loans to new risks.
11
The poverty rate has risen sharply since the onset of the recession, after a decade of relative stability, and it
now stands at 15 percent, significantly higher than the average over the past three decades. See Carmen
DeNavas-Walt, Bernadette D. Proctor, and Jessica C. Smith (2012), Income, Poverty, and Health Insurance
Coverage in the United States: 2011 (PDF), U.S. Census Bureau Current Population Reports P60-243
(Washington: U.S. Government Printing Office, September).
12
Data
See National Employment Law Project (2012), "The Low-Wage Recovery and Growing Inequality," Brief,
report (New York: NELP, August), http://nelp.3cdn.net/8ee4a46a37c86939c0_qjm6bkhe0.pdf.
13
These patterns were also observed during the recessions of the early 1990s and early 2000s - the so-called
jobless recoveries - but not prior to then. See Nir Jaimovich and Henry E. Siu (2012), "The Trend Is the Cycle:
Job Polarization and Jobless Recoveries," NBER Working Paper Series 18334 (Cambridge, Mass: National
Bureau of Economic Research, August); and Christopher L. Foote and Richard W. Ryan (2012),
"LaborMarket Polarization over the Business Cycle," Public Policy Discussion Paper 12-8 (Boston: Federal Reserve
Bank of Boston, December).
14
See U.S. Department of Labor, Commission on the Future of Worker-Management Relations (1994),
"Contingent Workers," in Fact Finding Report.
Wage gains have remained more muted than is typical during a recovery. While this
phenomenon likely partly reflects the trends in job creation that I have already discussed,
weak wage growth also reflects the severe nature of the crisis: Typically, those who are laid
off during recessions struggle to find reemployment that is of comparable quality to their
previous job, and research has shown that, on average, a person's income remains
depressed for decades following job loss, and that income losses over one's working life are
especially severe when the job loss occurs during a recession.15
Indeed, while average wages have continued to increase (albeit slowly) on an annual basis
for persons who have remained employed, the average wage for new hires has declined
since 2010.16 Although it is too early to state with certainty what the long-term effect of this
recession will be on the earnings potential of those who lost their jobs, given the severity of
the job loss and sluggishness of the recovery - with nearly 9 million jobs lost and still almost
2-1/2 million jobs below pre-recession employment levels - it is very likely that, for many
households, future labor earnings will be well below what they had anticipated in the years
before the recession.
Implications for our thinking about the macroeconomy
I have focused most of my remarks on the experiences of households at the lower ends of
the income and wealth distributions, those households whose incomes improved the least in
the years prior to the financial crisis and that suffered disproportionately as a result of the
crisis and ensuing recession.
To be clear, my approach of starting with inequality and differences across households is not
a feature of most analyses of the macroeconomy, and the channels I have emphasized
generally do not play key roles in most macro models. The typical macroeconomic analysis
focuses on the general equilibrium behavior of "representative" households and firms,
thereby abstracting from the consequences of inequality and other heterogeneity across
households and instead focusing on the aggregate measures of spending determinants,
including current income, wealth, interest rates, credit supply, and confidence or pessimism.
In certain circumstances, this abstraction might be a reasonable simplification. For example,
if the changes in the distribution of income or wealth, and the implications of those changes
for the overall economy, are regular features of business cycles, then even an aggregate
model without an explicit focus on distributional issues would capture those historical
regularities.
However, the narrative I have emphasized places economic inequality and the differential
experiences of American families, particularly the highly adverse experiences of those least
well positioned to absorb their "realized shocks," closer to the front and center of the
macroeconomic adjustment process. The effects of increasing income and wealth disparities
- specifically, the stagnating wages and sharp increase in household debt in the years
leading up to the crisis, combined with the rapid decline in house prices and contraction in
credit that followed - may have resulted in dynamics that differ from historical experience
and which are therefore not well captured by aggregate models. How these factors have
interacted and the implications for the aggregate economy are subject to debate, but I have
laid out some possible channels through which there could be effects and that I believe
represent some particularly fruitful areas for continued research.
Implications for monetary policy
The arguments that I have laid out suggest that paying attention to the experiences of
different types of households may be important for the way we understand and interpret the
macroeconomic events of the past several years. As a consequence, these differential
experiences may also have implications for the conduct of monetary policy. Arguably, the
FOMC's conduct of monetary policy in recent years has in part been designed to address
this particular landscape. In response to continuing low levels of resource utilization, the
FOMC has kept monetary policy highly accommodative by keeping its primary policy
instrument, the federal funds rate, at an exceptionally low level; by supplementing this move
with forward guidance about the funds rate; and by initiating unconventional policy actions
such as large-scale asset purchases. One channel through which these policies operate is
by putting downward pressure on longer-term interest rates, thereby encouraging firms to
invest in plants and equipment and helping enable households to purchase cars and other
durable goods and also to refinance their mortgages. Lower interest rates also support the
prices of homes and other assets, which can lead to additional spending. The resulting boost
to demand leads firms to hire and invest further, strengthening the economy as a whole. To
be sure, every household is different, and the particular mix of assets, skills, and
opportunities that each has will determine how much it is able to share in the recovery. But
accommodative monetary policy that lifts economic activity more generally is expected to
increase the odds of good outcomes for American families.
Of course, it is also relevant to consider whether the unusual circumstances - the outsized
role of housing wealth in the portfolios of low- and middle-income households, the increased
use of debt during the boom, and the subsequent unprecedented shocks to the housing
market - may have attenuated the effectiveness of monetary policy during the depths of the
recession. Households that have been through foreclosure or have underwater mortgages or
are otherwise credit constrained are less able than other households to take advantage of
the lower interest rates, either for homebuying or other purposes. In my view, these effects
likely clogged some of the channels through which monetary policy traditionally works. As the
housing market recovers, though, I think it is possible that accommodative monetary policy
could be increasingly potent. As house prices rise, more and more households have enough
home equity to gain renewed access to mortgage credit and the ability to refinance their
homes at lower rates. The staff at the Federal Reserve Board has estimated that house price
increases of 10 percent or less from current levels would be sufficient for about 40 percent of
underwater homeowners to regain positive equity.
It is my view that understanding the long-run trends in income and wealth across different
households is important in understanding the dynamics of the macroeconomy and thus also
may be relevant for setting monetary policy to best reach our goals of maximum employment
and price stability. I believe that the accommodative policies of the FOMC and the concerted
effort we have made to ease conditions in the mortgage markets will help the economy
continue to gain traction. And the resulting expansion in employment will likely improve
income levels at the bottom of the distribution. However, given the long-standing trends
toward greater income and wealth inequalities, it is unlikely that cyclical improvements in the
labor markets will do much to reverse these trends.
Conclusion
It strikes me that macroeconomists are far from a comprehensive understanding of how
wealth and income inequality may affect business cycle dynamics. My remarks today are
given only in the spirit of describing how that relationship might be further explored. I have
said nothing about the social costs associated with such trends, nor have I provided much
detail on what is occurring at the top end of the income and wealth distribution and the
effects of those trends on the recovery. Nonetheless, I believe that, given the wide income
and wealth disparities in the United States, this area is ripe for more research.
In recent years, the Board has increased its efforts to measure and understand differences in
the economic situations faced by different types of families. A particularly strong source of
data to improve our understanding of the role for inequality and heterogeneity is the SCF.
The triennial SCF marks its 30th anniversary this year, as the fieldwork