Household debt, expected economic conditions, and income inequality

• DOI: http://doi.org/10.1002/ijfe.1616
• Author: Edmond Berisha,John Meszaros
• Date: 01 July 2018
• Published date: 01 July 2018

RESEARCH ARTICLE

Household debt, expected economic conditions, and income

inequality

Edmond Berisha

1

| John Meszaros

2

*

1

Feliciano School of Business, Montclair

State University, Montclair, NJ 07043,

USA

2

U.S. Postal Service, Washington, DC,

USA

Correspondence

Edmond Berisha, Feliciano School of

Business, Montclair State University,

Montclair, NJ 07043, USA.

Email: berishae@mail.montclair.edu

JEL Classification: D31; G12

Abstract

The high level of debt among households outside the top end of the income dis-

tribution has led many economists to assert that household debt has been an

important component of the increase in income inequality in the United States.

In addition, the yield spread provides information about the overall condition

of the economy and may also be tied into the distribution of income. The

paper's results show that increases in the yield spread and household debt cor-

respond with increases in top income shares, resulting in increases in income

inequality. However, as household debt and income inequality increase, the

yield spread contracts, which suggests future economic contraction. Thus, ris-

ing inequality may signal future economic weakness.

KEYWORDS

economic growth,household debt, income inequality

1|INTRODUCTION

U.S. household debt relative to income has increased sig-

nificantly over the last century. As shown in Figure 1, the

largest increase occurred during the years prior to the

Great Recession, particularly during the years 2006 and

2007, where debt was at its peak level of 130% of house-

hold income.

The increase primarily represents households'

attempts to smooth consumption over time on the expec-

tation of increases in future income (Dynan & Kohn

2007). Similarly, Mian, Sufi, and Verner (2015) have sug-

gested that over‐optimistic expectations about the future

are likely to contribute to credit demand by households.

Thus, observing the high leverage ratio of households

has led many economists to explore the role debt plays

in driving overall macroeconomic conditions. Mian et al.

(2015) show that household debt matters for subsequent

changes in economic conditions. Growth in household

debt over a 3‐to 4‐year period predicts subsequently lower

output growth and increases in unemployment. Cecchetti,

Mohanty, and Zampolli (2011) document that borrowing

can be beneficial as long as it is modest. However, at high

levels, debt increases volatility and impedes growth.

It should be noted that the overall increase in the

household debt level observed from the data was mainly

concentrated among the households outside the top of

the income distribution (Barba & Pivetti 2009; Cynamon

& Fazzari 2013; Debelle 2004). This is illustrated in

Figure 2.

Using data from the Survey of Consumer Finances,

Figure 2 shows that only for the households in the top

10% of the income distribution has the debt‐to‐assets ratio

remained constant over the last 24 years. Whereas the

other households experienced increases in leverage that

ranged from 5% to nearly a 10% increase depending on

the specific income groups. Furthermore, Figure 3 decom-

poses the balance sheet components of wealthy house-

holds and households in the bottom 60% of the income

*

This research was prepared by the author in his personal capacity. The

opinions expressed in this article are the author's own and do not neces-

sarily reflect the views of the United States Postal Service or the United

States government.

Received: 10 April 2016 Accepted: 13 December 2017

DOI: 10.1002/ijfe.1616

Int J Fin Econ. 2018;23:283–295. Copyright © 2018 John Wiley & Sons, Ltd.wileyonlinelibrary.com/journal/ijfe 283