Debt Shift, Financial Development and Income Inequality

Abstract

Does financial development increase income inequality? Ambiguous answers to this question may be due to over-aggregation of 'financial development'. In a sample of 40 developed economies over 1990-2013, we study the effects on income inequality of different components of financial development. There was a shift in bank credit allocation, away from supporting investments by non-financial firms and towards financing real estate markets ('debt shift'). In system-GMM estimations, we find that mortgage credit increases income inequality while credit to non-financial business reduces inequality. The effect of business credit is conditional on macroeconomic and labor market factors related to broader income formation, such as wage share, investment, trade openness, and labor force participation. House prices and the size of the real estate sector condition the impact of mortgage credit on income inequality.