Rising Debt or Inequality As Drivers of Aggregate Demand?
The effects of the changes in income distribution on aggregate demand, and the role of debt and financial assets, are two intensely debated issues in modern heterodox macroeconomics. This corresponds to important changes in contemporary capitalism. Since 1980, dramatic shifts in the distribution of income and in the valuation of assets have occurred. The adjusted wage share has been falling in all major OECD countries, and top incomes as well as property prices and household debt have increased in most but not all countries. While there is agreement on the trends and on their importance, there is disagreement on their impact.
This paper investigates the effects of changes in the distribution of income and wealth on aggregate demand and its components. The theoretical framework for the econometric analysis is provided by an extension of the Bhaduri and Marglin (1990) model that includes personal income inequality as well as asset prices and debt. First, we evaluate the wage or profit-led nature of demand regimes. As Kaleckians have argued, an increase in the wage share will increase aggregate demand (wage-led demand regime) because the propensities to consume out of wages is higher than that out of capital incomes (Kalecki 1954). On the other hand, Marxists (Goodwin 1967) argue that higher profits translate into higher investment (profit-led demand regime).
Secondly, we evaluate the expenditure cascades argument recently popularized by Frank et al. (2010). These authors point out that consumption decisions are also used to signal social status. People will emulate consumption patterns of richer peers in an attempt to climb up the social ladder which in the end can boost aggregate consumption spending. This contrasts the standard Kaleckian hypothesis which states that rising inequality will lead to lower consumption expenditures as the rich will have a lower consumption propensity than the poor. Third, we address the fact that while there is an agreement on the key role of debt and wealth in Post-Keynesian macroeconomics, there is no agreed-upon model. In Minsky’s (1995) analysis business debt is central. This clearly does not fit the recent experience of a household debt-driven consumption boom. There are also important differences based on whether gross or net wealth and stock or flow variables are used (Godley and Lavoie 2007).
Our estimates are based on a panel of 18 OECD countries covering the period 1980-2013. For the full panel, the average demand regime is found to be wage led. We fail to find effects of personal inequality, but do find strong effects of debt and property prices which seem to have been major drivers of aggregate demand in the decade prior to the 2007 crisis, contributing almost 10% to GDP growth in that period.