The United States experienced two major economic crises over the past 100 years—the Great Depression of 1929 and the Great Recession of 2007. Income inequality may have played a role in the origins of both. We say this because there are two remarkable similarities between the eras preceding these crises: a sharp increase in income inequality and a sharp increase in household debt–to-income ratios.
Are these two facts connected? Empirical evidence and a consistent theoretical model (Kumhof and Rancière, 2010) suggest they are. When—as appears to have happened in the long run-up to both crises—the rich lend a large part of their added income to the poor and middle class, and when income inequal- ity grows for several decades, debt-to-income ratios increase sufficiently to raise the risk of a major crisis.