Income inequality and household debt: A U.S. state-level spatial analysis

Abstract

While most agree that the 2007–2008 financial bust stemmed from an excessive credit boom, researchers disagree about the causes of the boom amid income inequality, monetary excesses, and an unregulated credit market. Empirical findings on inequality's impact on credit booms are contradictory. This paper examines the impact of income inequality on household debt, utilizing U.S. state-level data from 1999 to 2015 within macroeconomic and credit market contexts. Diverging from prior research, it provides consistent and robust estimates by using the control function approach to identify exogenous variations in inequality and employing a spatial error panel model to remove significant cross-sectional dependence. The results indicate that inequality indices have a negative or insignificant effect on household debt, while monetary policy and credit market uncertainty also affect household debt. Thus, higher inequality is linked with credit contraction rather than expansion; rising inequality does not trigger a credit boom.