Thursday, April 16, 2009

More On Inequality & Bubbles

Justin Fox at Time magazine has discovered that there is a strong empirical link between asset price bubbles and economic inequality, and also argues that there is a causal link between the two, while conceding that this is not a new theory.

Which it certainly isn't, I have repeatedly (for example here and here) pointed to asset price inflation caused by monetary inflation as the primary cause of the increase in inequality.

Fox however offers no explanation for these bubbles, except he simply says that they were based on "some real economic reason, then got out of hand". That makes little sense, because first of all, to the extent an increase in asset values is based on improving fundamentals, it is not a bubble. And regarding the more relevant point of the effect on inequality, there is no reason per se that for example the improved productivity during the 1920s (or to a lesser extent, the late 1990s) would disproportionately boost corporate profits relative to labor income.

What instead happened is that there were gains in productivity that caused consumer prices to decline, something which caused the inflation targeting Fed to increase money supply, which in turn boosted corporate profits and also increased valuation levels (because of lower interest rates). In other words, it is monetary policy that causes the increase in inequality.


Blogger Aragon said...

Quasi-austrian George Reisman makes in his relatively recent article almost exactly the same notion about 1920s and 1990s as you do:

"It is not accidental that the two leading periods of credit expansion in history — the 1920s and the period since the mid-1990s — have been characterized by a major increase in economic inequality."

7:07 PM  

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