Debt and Inequality

Will Wilkinson is responding to commenters on his inequality paper. Ezra Klein brought up worries about debt and households (worries that echo my own), especially the recent dramatic increase in debt/income we see in this graph:

Here is Will’s response (my underline):

That said, I suspect many lower-income households have over recent years increased their level of debt, and I suspect that this has played some small role in keeping consumption inequality in check…So, yeah, lots of people who wrongly thought they were house-rich ran up their credit cards. I think it’s safe to say that there was “too much” debt-financed consumption. But I would hazard to guess that, on the whole, this would tend to widen rather than narrow the income and consumption gaps

That incomes at the top are now so sensitive to aggregate consumption (it didn’t use to be that way, Parker and VIssing-Jorgensen say) would seem to at least partly explain the coincidence of very high average debt-levels and high levels of inequality that Ezra emphasizes later in his post.

Folks were running up their credit cards because they thought they were house-rich. They thought they were house-rich because they were in the middle of a housing boom that made the current and future value of their houses look a lot higher than they really were. Those with compensation schemes highly sensitive to changes in aggregate demand–high income households–saw a disproportionate rise in already high income as consumption boomed. So income inquality went up.

I don’t want to put words in Will’s mouth, but I believe he is saying one of two things here. (1) The increase in debt reflects an increase in debt-fueled consumption at the top 10-20% of the income distribution, and as such will increase the amount of consumption inequality we see as top earner fuel consumption with debt. (2) The debt increase among everyone will fuel the earnings of the top 1% (or top .01%) of earners, increasing consumption inequality between the top 1% and the bottom 99%, because increases in aggregate consumption are linked via Parker and VIssing-Jorgensen’s paper. Even if Will isn’t making these points, they get made by others so I want to examine them.

Now remember our original assumptions: Income inequality is large. Consumption inequality is smaller. So savings inequality must be huge. Money doesn’t spoil if it isn’t spent, it goes towards investments/savings/etc. Fair enough, and the point of consumption inequality is just to focus on consumption. The problem with just focusing on consumption is you lose sight of the ways in which consumption/savings/debt are all part of the same thing.

One brings up that a lot of this consumption is debt fueled. A response is “yes, but clearly those spending more at the top must be taking out more debt to fuel that consumption, because they are spending so much more on consumption.” See how we lost our original assumption, looking at just consumption? We started under the assumption that the rich are saving a lot more in addition to consuming more. Those who make this point say that those at the top of the income distribution should have increased their debt burden, but looking at all inequalities together we know that the debt burden must decline, since the top’s savings inequality is increasing faster than their consumption inequality.

And it does. From the Federal Reserve’s Changes in U.S. Family Finances from 2004 to 2007: Evidence from the Survey of Consumer Finances, two charts:



The first chart is the leverage ratio – debt/assets, by income distribution. From 1998-2007 (as well as 2004-2007) we see the leverage ratios of the top 10% decline, while the leverage ratios of the 20%-90% range of household income range skyrockets. Notice that the average overall doesn’t change much, but the dynamics underneath involves a lot of shifting around, with the biggest percent gains in the 20-60% of the distribution.

The second chart (click through to see the whole thing) is the ratio of debt payments to family income. We are interested in the first two boxes, which are the aggregate and median for debtors. Once again, same dynamic. From 1998-2007 (as well as 2004-2007) we see the debt payment ratio of the top 10% decline, while the leverage ratios of the 20%-90% of household income range increases. Mind you, because of the way these numbers get to us, a small increase can translate as a giant increase in bankruptcies and troubles. The second set of boxes are important, because Will says that the Parker/VIssing-Jorgensen says that the debt consumption should impact the top 1% of earners disproportionately; however the median value, so those at 95% of income, also see a similar decline.

So I still think we have a story about the middle-class and working-class debt consumption. While there was a relatively flat consumption inequality trend, there was a massive difference in leverage, where those at the bottom were leveraging up and those in the top 10% deleveraging. As far as the first graph on debt-to-income goes, the debt-to-income of the top 10% are actually slowing down the increasing trend.

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8 Responses to Debt and Inequality

  1. chrismealy says:

    Oh come on! Didn’t you learn anything from Milton Friedman?! Those middle-class folks financing their consumption through debt are just smoothing their consumption. This just proves they’ll make more money in the future. And the rich will make less in the future because everything returns to the mean anyway.

    Ok, just kidding. Good post (and score another point for Robert H Frank). I don’t know why Will didn’t do this himself. Too good to check I guess.

    btw, you ever look at the consumption-wealth ratio stuff?

  2. Mike says:


    ha! Clearly it has little to do with rising costs of fixed expenditures of the household and is simply a prediction that things are extra-super-allright sometime in the future. On a long enough timeline….

    I am not familiar with the research on consumption-wealth ratio; because of my background in theory and practice I tend to look at leverages/debt ratios. Personally I think the debt numbers are more solid and the consumption data not all that trustworthy; if there was a bridge built based on how accurate the consumption numbers at the top/low ends are I wouldn’t drive across it (but that’s a seperate story; we are taking it for granted it is correct here). What should I be checking with consumption-wealth ratio?

  3. Frankly, I find this whole conversation on the “consumption equality” between the top tier and everyone else to be appalling. Absolutely appalling.

    Wilkinson says this in the post you link to: “Let me add that I don’t think pre-recession wage stagnation has been exactly widespread. It has been suprisingly focused on low-skill, male workers.” (Typo Wilkinson’s!)

    Huh. Would love the figures to support that claim.

    I guess this story is wrong:

    And I guess this is irrelevant:

    What I see – a middle class that has seen no income growth in a very long time. And at the same time their income is stagnant, costs for pretty much everything is rising.

    In my old neighborhood in Chicago, you used to be able to buy a house for under $200K. Not even 12 yrs ago. Today, that option has vanished, with houses now going for at least $450K for the fixer uppers. (And that’s the market since the crash – they used to be even more expensive!) How can a teacher or a cop or anyone else earning the median income of $50K afford that? Seriously? Should the middle-class just search the slums for housing?

    In this Vox EU story – – what do the authors point to as the source for diminishing inequality? Education. So what do we seen with higher education? Costs outstripping the middle class’ ability to pay for it.

    In Illinois, the cost to go to our public colleges has tripled in less than a decade. This year, we’re celebrating the fact that our in-state tuition hasn’t go up as much as in previous years. Whoopie!,CST-NWS-tuition02.article

    And I think talking about how consumers have “debt-financed consumption” issues in the year since seeing the banks bailed out because of the debt on their books just a diversion. Banks loaded up on debt to the point it became toxic to the economy – but the debt-ridden consumption of the middle class is what toppled the economy? Paulson didn’t bail out banks to save consumers – he bailed out banks because of their own private stores of toxic debt. Highly paid capitalists are far superior in running up debt than consumers ever will be.

    Will is right about one thing – we’re not slumdogs of India. Most of us have a roof over our heads and a refrigerator to keep milk chilled. However, he’s looking through some kind of horribly distorted lens if he thinks that the grotesque income inequality that we’ve seen in America in the last quarter century is irrelevant because of that.

    Middle class families are running up their credit cards because their incomes can no longer keep pace with the costs of things to buy. College. Homes. Cars. All those extraneous things those middle class people so greedily wanted to acquire.

  4. Mike, Great post. Of the two points you think I might have been making, I was definitely making (2): debt-fueled consumption will have disproportionately increased income (and, to a lesser degree, consumption) at the top of the distribution. I take this to be the lesson from Piketty and Saez and Vissing and Jorgensen.

    I’m agnostic about (1), since I’m not aware of the relevant data. Since income gets more sensitive to aggregate consumption the higher you go in the distribution, it would make sense that huge boom-related performance-based incomes at the very top would have led to significant deleveraging in the nosebleed range of the distribution. I think that’s what you’d expect if people are making more money than they can spend.

    Your leverage ratio chart is consistent with my sense of things, I think. Actually, I’m a bit surprised that some of the increases from 98-07 are as modest as they are. Anyway, most of the action seems to be in the quintiles most likely to have a lot of their wealth and debt tied up in houses.

    And I still intend to get around to answering your first set of questions!

  5. chrismealy says:

    The consumption-wealth ratio stuff is over my head, but the basic idea is that it might be able to predict asset returns. The paper that introduced it is “Consumption, Aggregate Wealth, and Expected Stock Returns”

    Click to access LettauLudvigsonJF2001.pdf

    When you google a bit with it you find a lot of follow-ups trying to deal with the poor quality and latency of consumption data.

    It’s funny how the prices of stocks and bonds get a lot more attention than household income, consumption, and wealth. It’s like the drunk looking for his keys.

  6. Mike says:

    Thanks Will! I’m been meaning to dig up this data on quintile debt and post it for a while, so I figured this would be as good of a time as any.

    Chris, I’ll check it out. The data quality issue is also of interest when it comes to mutual funds, etc., because they often survive gamed survivorship bias. There’s a whole other range of bias issues with consumer data that makes it very tough to do.

  7. David says:

    Really good work on evolution of inequality from the Guvenen, Kuruscu camp, a pair of which just came out in NBER working paper. “A Quantitative Analysis of the Evolution of the U.S. Wage Distribution: 1970-2000”
    They show a pretty convincingly that income inequality has spread considerably but consumption inequality not so much. And as income inequality increases dramatically, that there’s a huge spread as people get older. Basically it’s an education story, so people who will earn more in the future consume a lower portion of lifetime income in their youth relative to those with flatter income profiles. Education-augmenting technology changes accentuated the increase later in life to highly skilled, but also convinced people to get more education, and thereby increase the variance of their income even more. By their data “debt fueled consumption” is the saving grace. People’s income gets more unequal because some are foregoing earning for school, then earning more later, while others will have much lower peak earning. The only reason this more unequal earning pattern is not costly in terms of welfare is because we have good credit markets.

  8. stacy says:

    Interesting article. Debt is a complicated thing, expecially during these difficult economic times, and that’s why the debt industry is changing. Have you heard about the new proposal to change the debt industry completely? It’ll be great for the consumer. But already adheres to the new proposal, so feel free to check them out whenever you need debt help.

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