Financial fragility and income inequality

After the financial crisis of 2007/2008 academics and policymakers have turned their attention to how private debt can affect, significantly, the economic performance of a country. In the period of the “Great Moderation”, the increasing level of income inequality, together with structural transformations, has created an environment where a large portion of the private sector was more prone to rely on bank credit in order to finance its expenditure. While borrowing can have a first expansionary impact, because of the increase in the purchasing power of the borrowers, the increase in the stock of debt in the “medium-term” can have different negative effects. Debt repayment transfers resources to “high propensity to spend” agents (borrowers) to “low propensity to spend” agents (lenders). The impact of this income transfer can have a negative impact on final expenditure and, thus, on GDP. The increase in the stock of debt leads to an increase of the fragility of the household sector because of its increase in the vulnerability to different kind of shocks such as: an increase of the interest rates, a sudden decrease of the disposable income, a collapse of the assets used as collateral, and to possible changes of the attitudes of the lenders. Starting from this, we developed three different theoretical models in order to describe the impact of an expansion of household debt, in an environment of high-income inequality.