On Income Inequality: The 2008 Great Recession and Long-Term Growth

Income inequality has been relatively neglected in mainstream macroeconomics until recently, when the work of Stiglitz and Piketty, inter alios, has given it a higher profile. The standard view is that markets generally work efficiently in allocating resources and there is little cause for concern. This chapter disputes these views and makes the argument that the degree of inequality does matter. We show that the increase in income inequality (especially the increase in the share of the top one percent) over the last twenty years has led to an unsustainable increase in household debt, which is a reason why the 2008 crisis was so deep. Furthermore, turning to the long run, there is accumulating evidence that higher inequality lowers economic growth. Consequently, increasing inequality has had a short-term adverse effect on the level of economic activity as well as reducing the long-term rate of growth. Finally, we conclude by looking at the evidence as to what are the major determinants of income inequality.