Political Aspects of Household Debt

The recent literature has shown that income inequality is one of the main causes of borrowing and debt accumulation by working households. This paper explores the possibility that household indebtedness is an important cause of rising income inequality. If workers experience rising debt burdens, their cost of job loss may rise if they need labor-market income to continue borrowing and servicing existing debt. This, in turn, will reduce their bargaining power and increase income inequality, inducing workers to borrow more in order to maintain consumption standards, and so creating a vicious circle of rising inequality, job insecurity, and indebtedness. We believe that these dynamics may have contributed to observed simultaneous increases in income inequality and household debt prior to the recent financial crisis. To explore the two-way interaction between inequality and debt, we develop an employment rent framework that explicitly considers the impact of workers' indebtedness on their perceived cost of job loss. This is embedded in a neo-Kaleckian macro model in which inequality spurs debt accumulation that contributes to household consumption spending and hence demand formation. Our analysis suggests that: (1) workers' borrowing behavior plays a crucial role in understanding the character of demand and growth regimes; (2) debt and workers' borrowing behavior play an important role in the labor market by influencing workers' bargaining power; and (3) through such channels, workers' borrowing behavior can be a decisive factor in the determination of macroeconomic (in)stability.