The bubble, bust, repeat cycle begins with the inequality wedge, as shown in this figure by EPI’s Elise Gould.
Jared Bernstein, a former chief economist to Vice President Joe Biden, is a senior fellow at the Center on Budget and Policy Priorities and author of 'The Reconnection Agenda: Reuniting Growth and Prosperity'.

That the U.S. economy is generating historically high levels of economic inequality, by wages, incomes, and wealth, is not under dispute (I mean, you can always find “flat-earthers” but they are, or at least should be, irrelevant). Why and whether it matters, on the other hand, is an active and important question.

In recent work with my CBPP colleague Ben Spielberg, we’ve identified four basic reasons why our historically high levels of inequality are problematic. First, inequality creates a wedge between any level of growth and the income of many in the economy. Think of the productivity/compensation split pictured here — the “wedge” is evident.

Second, while inequality is a pervasive factor in economies across the globe, when it gets high enough it can create barriers to opportunity and mobility, often through human capital investment channels.

Third, the toxic combination of high levels of wealth concentration and our increasingly money-driven politics interacts in ways that threaten representative democracy and critical regulatory functions of government.

We will, in coming days, be posting a comprehensive, evidence-based presentation of these arguments, but here, we’d like to focus on number four: the potentially negative impact of inequality on macroeconomic growth.

The usual channel through which this effect is argued is through different consumption propensities throughout the income scale. If the wealthy a) get most of the growth, and b) tend to save it rather than spend it, then it’s reasonable to predict slower growth in a 70 percent consumer spending economy like ours. I suspect that’s operative in the current economy — and one reason for what’s been heretofore a slow recovery — and there’s some evidence to support it.

But there’s a less well explored or understood channel by which inequality hurts growth, summarized by the diagram below:

As shown, as the “wedge” between overall growth and the compensation of the typical worker grows, higher income households are expected to increase their savings.  Middle class households, on the other hand, must borrow more to maintain their living standards; as they do, their debt-to-income ratios begin to rise. This leads to an expansion in the financial sector, as noted by Michael Kumhof and Romain Ranciére: “the bottom group’s greater reliance on debt – and the top group’s increase in wealth – generated a higher demand for financial intermediation” during the 2000s expansion.

In the absence of sufficient financial market oversight — itself arguably a function of the interaction of wealth concentration and money in politics — financial markets become increasingly unstable and the system eventually crashes. Borrowers aggressively deleverage while wealth effects quickly shift into reverse, leading to a contraction in overall demand and recession.

Economists Barry Cynamon and Steve Fazzari have thus far done the most careful empirical investigation of the sequence in the above schematic, concluding that “the rise of inequality is easily large enough that it could potentially account for the entire increase in bottom 95 percent debt leverage, an increase that spawned the Great Recession” (emphasis theirs).

One study, of course, doesn’t prove the existence of what is an admittedly complex chain. And it is important to recognize that large financial bubbles have inflated in periods of low-levels of inequality as well. But the dynamics described by ourselves and others are arguably operative and are plausibly driving the economic shampoo cycle — “bubble, bust, repeat” — that’s characterized the U.S. macroeconomy over the period when inequality has grown.

In future posts, I’ll elaborate the other problems — the growth wedge, opportunity barriers, and the impacts on the functioning of our democracy. But the punchline is this: The impacts of our high levels of inequality are both numerous and consequential.