Not all banking crises are alike: Assessing their distributional impacts relative to pre-crisis credit gaps

Abstract

The empirical literature on the effects of banking crises on income inequality has yielded mixed findings. In this paper, we aim to reconcile these mixed results by evaluating the effects of banking crises on income inequality in relation to pre-crisis credit gaps. We apply the Local Projections methodology to a yearly panel of 68 banking crises that occurred in 59 countries over the period 1970–2017. Three key results emerge. First, banking crises lead to increased income inequality. Second, only those banking crises preceded by larger credit gaps show a significant increase in income inequality. Third, a deeper contraction in the credit supply and a higher unemployment rate are two channels that could potentially explain why inequality rises more after banking crises with larger pre-crisis credit gaps. These results underscore the importance of macroprudential policies that, as well as limiting the amplitude of the financial cycle and the associated risks of financial crises, could also play a key role in reducing the distributional consequences of banking crises.