The Political Economy of Easy Credit Policies

Abstract

During the past thirty years, U.S. economic growth has disproportionately benefited the richest percentiles of the American population, i.e., the top income earners. Although this phenomenon is difficult to explain from a “standard” political economy perspective (i.e., majority voting), recent literature emphasizes the role of consumer credit as a means of circumventing costly public redistribution. According to this theory, most OECD and, notably, American policymakers should have facilitated middleclass and low-income households’ access to consumer credit to cushion the effects of increased income inequality (i.e., an increased share of GDP held by top earners). Our contribution to this literature is to argue that increases in inequality (as measured by expansions in the share of GDP held by top income earners) should be associated with aggregate consumption increases. Indeed, in response to increased inequality, easy credit policies stimulate low-income and middle-class consumption, which contributes to an increased aggregate consumption level. Using a panel dataset of 20 developed OECD economies between 1980 and 2007, we show that such increases in inequality are actually associated with expansions of aggregate consumption. Finally, when computing marginal effects, we conclude that these expansions increase with the size of the financial sector.