The concept of “keeping up with the Joneses” has been around for more than a century. But in an era of high inequality, the pressure to match the lavish lifestyles of one's neighbors has become all the more salient.
A new paper from a Federal Reserve economist explores a potentially alarming way these pressures affects people's financial lives. The paper from Fed economist Jeffrey Thompson suggests that Americans are borrowing more to keep up with wealthier members of society — particularly when it comes to buying and financing homes.
Thompson's study offers a window into a less widely understood aspect of rising inequality. It's not only that rising wealth at the top might make people lower down the income scale feel inadequate. It's also that people who are aiming to live in the town they always have might have to pay more for housing because the wealthiest there have managed to boost property values for other top-percenters, but income gains among the less well-off have lagged.
Indeed, overall, the growth in housing prices has eclipsed income gains nationwide, making even maintaining a similar quality of life more challenging for many people. You can see that on the chart on the below, by Cornell economist Robert Frank, which shows how median wages have failed to keep up with the prices of homes.
"One potential consequence of rising concentration of income at the top of the distribution is increased borrowing, as less affluent households attempt to maintain standards of living with less income," Thompson writes. He notes that in areas where upper-income people have seen higher levels of wage growth — more inequality — people are paying even more for mortgages. "Payments on mortgage debt are higher in states where the high-income thresholds are higher."
This chart from Thompson's study shows how the top income percentiles have changed since 1989 in each state. For example, you can see that the cut off for the top 1 percent of earners increased by nearly $200,000 in Connecticut, the nation's hedge fund capital, from 1989 to 2013. According to his paper, the top 1 percent now earns a minimum of $641,070 in Connecticut. Meanwhile, in North Dakota, which has experienced a stunning energy boom in the past 10 years, the cut off for the top 1 percent has increased by over $250,000. The minimum income for the top 1 percent there is now $485,177.
In most cases, there were increases, though much less pronounced, at the 95th and 90th percentiles.
Using this data for each state, Thompson sought to determine how rising incomes at the top could increase overall mortgage indebtedness — measured as the ratio of an individual's debt payments to his overall income. His statistical analysis revealed a link between increases in income at the top and higher payment-to-income ratios.
As the 95th percentile cutoff in a state rises by $10,000 — controlled for factors like cost of living and tax — the ratio of the bottom 95 percent's income spent paying back a mortgage increases by about .32 percentage points. It's worth noting that from 1989 to 2013, the 95 percentile cutoff in many states — including Colorado, Connecticut, Massachusetts, Minnesota, North Dakota (and the District of Columbia) — increased by more than five times as much.
In many others it was three or four times as much, suggesting the actual increase in the indebtedness ratio would easily be 1 to 2 percentage points. Almost all of this effect would be on the top half of the income distribution.
“It could be that rising top incomes are fueling increased housing consumption at the top, which in turn inspires debt-financed housing consumption further down the distribution,” Thompson wrote.
Thompson's paper is not the only scholarship to suggest this phenomenon. Other scholarship has indicated that the middle-class are struggling for no greater increase in quality of life.
For example, one 2015 study by Neil Fligstein, Pat Hastings, and Adam Goldstein at the University of California at Berkeley, found that those outside of the top fifth of earners spent more on homes for the same quality.
“Rising prices pushed them to increase their share of expenditure on housing and their mortgage debt-to-income ratio even when they did not upgrade house size or neighborhood,” the authors wrote.