Jim Meehan

The Inequality Trap

In the early twentieth century, some argued that capitalism tends to generate chronic weakness in effective demand, as growing concentration of income leads to a “savings glut.” Nowadays, with income inequality on the rise, that argument has returned.

WASHINGTON, DC – As evidence mounts that income inequality is increasing in many parts of the world, the problem has received growing attention from academics and policymakers. In the United States, for example, the income share of the top 1% of the population has more than doubled since the late 1970’s, from about 8% of annual GDP to more than 20% recently, a level not reached since the 1920’s.

While there are ethical and social reasons to worry about inequality, they do not have much to do with macroeconomic policy per se. But such a link was seen in the early part of the twentieth century: capitalism, some argued, tends to generate chronic weakness in effective demand due to growing concentration of income, leading to a “savings glut,” because the very rich save a lot. This would spur “trade wars” as countries tried to find more demand abroad.

From the late 1930’s onward, however, this argument faded as the market economies of the West grew rapidly in the post-World War II period and income distributions became more equal. While there was a business cycle, no perceptible tendency toward chronic demand weakness appeared. Short-term interest rates, most macroeconomists would say, could always be set low enough to generate reasonable rates of employment and demand.

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