Did increased inequality cause the Great Recession?

Tim Congdon

Published: September 2015

This paper considers the basis of the thesis of left-wing economist Thomas Piketty, the author of Capital in the Twenty-First Century, that “a market economy based on private property” has “powerful forces of divergence” which are likely to increase future inequality. Although Picketty’s “fundamental contribution” has been lauded as a contribution in the field of data collection and presentation, Piketty’s book contains a number of “explanatory narratives”, with descriptions of events and the identification of possible causes. This paper considers its treatment of one such narrative, that rising inequality was a principal cause of the Great Recession of 2008 – 2010. An analysis of data on the US economy in the Great Recession shows that the behaviour of the corporate sector, unrelated to personal income inequality, was responsible for about half of the drop in demand. In contrast, the personal sector, where inequality could matter, experienced falls in residential investment and in personal consumer expenditure, but a long run investigation found no relation between the degree of inequality and the stability of the housing market. Finally, an econometric analysis of the effects of personal disposable income and debt on consumption, two variables highlighted by Picketty, showed them to have had close to no impact on the recorded change in consumption.