Debt, inequality and house prices: Explaining the dynamics of household borrowing prior to the great recession

Abstract

Was the growth in income inequality a direct driver of the growth in US household debt levels ahead of the 2007–2008 financial crisis? I study the link between income inequality and US households’ consumption and saving decisions, by exploiting multiple microdata sources and constructing measures of geographical variation in top incomes over time. I show that the relationship between consumption and saving rates of low and middle-income American households appears to be strongly mediated by the role of homeownership and rising house prices. The consumption response to changes in top incomes is insignificant throughout this decade, but is significantly higher for homeowners than for renters. Homeowners also accumulate more debt in response to a change in top incomes, albeit exclusively in the form of mortgages. Furthermore, the concentration of income in the top two deciles of the distribution is positively correlated with the growth in values of owner occupied houses. These results indicate that the cost, wealth and collateral effects affecting homeowners living in high-inequality areas may provide an alternative explanation for the link between rising income inequality and the growth in household leverage, insofar explained on the basis of a consumption emulation mechanism.