Extreme inequality in the US is making a major economic problem even worse

US inequality may have prolonged the Great Recession, and it leaves the economy vulnerable to weak growth and the risk of fresh downturns.
New research from the Chicago Fed explores "whether the widening gap between the rich and poor has any direct effects on macroeconomic aggregates."
The authors find that "various measures of household constraints have permanently increased in the wake of the Great Recession, raising the need for caution."

US inequality has become so extreme that hyperbolic headlines about how much wealth is in the hands of a few families in this country have ceased to shock.

But economists are increasingly worried that inequality is not just hurting the poor but also dampening the overall economy's growth potential.

Three researchers at the Federal Reserve Bank of Chicago reviewed the recent literature on the issue to examine whether "the changing distribution of wealth intensified and lengthened the effects" of the Great Recession of 2007-2009.

"It is important to ask whether the widening gap between the rich and poor has any direct effects on macroeconomic aggregates and, in particular, on the severity of the Great Recession, when output and consumption dropped precipitously and were slow to recover," Gene Amromin, Mariacristina De Nardi and Karl Schulze wrote in a Chicago Fed Economic Letter.

US inequality has gotten so bad in recent years that researchers have been forced to drill down into the gap between the top and bottom of the richest 1%. The most influential research has come from the economists Thomas Piketty, Emmanuel Saez, and Gabriel Zucman.

Piketty and Saez find that the income share of the top 1% of Americans rose to roughly 22% from 15% between 1995 and 2015. The income share of the top 0.1% rose to 11% from 6%, while the income share of the top 0.01% rose to about 5% from 2.5% during that two-decade period.

After-tax income nearly tripled for the top 1% from 1980 to 2014; it almost quadrupled for the top 0.1%. And posttax income for the 0.01% surged 423%.

In contrast, after-tax income for the entire US population rose 61%.

The Chicago Fed authors argue that high inequality, unmatched in other developed nations, reinforces "the importance of thinking about borrowing constraints and marginal propensities to consume in richer frameworks in which the constraints are not simply synonymous with holding little in the way of net worth."

In practice, this means strong overall economic growth can mask substantial pockets of weakness and vulnerability among lower-income consumers.

"The models also stress the consequences that unequal access to financial liquidity can have on consumption dynamics during an economic downturn," they write.

"As we show, various measures of household constraints have permanently increased in the wake of the Great Recession, raising the need for caution in thinking about an economy’s response to aggregate shocks."