Wednesday, February 5, 2014

Is Financial Inequality Constraining Economic Growth?

Businesses are having trouble raising prices.  (See  Consumers resist price increases and look for cheaper alternatives.  The stagnation of middle class incomes surely plays a large role in keeping downward pressure on prices.  With people becoming wary of debt, the decline in the real incomes of the middle class leaves folks with no choice except not to spend money they don't have.

It's become an article of faith among central bankers that a little inflation--in the 2.0 to 2.5% range--promotes economic growth.  And they strive for such a Goldilocks level of inflation.  Whether or not this actually will work isn't clear.  Inflation isn't like the flow of water from a faucet, which can be kept at a desired level while economic growth blossoms.  A slithering rattlesnake, sometimes moving slowly and sometimes moving quickly but always potentially dangerous, is a better analogy for inflation. 

Nevertheless, let's posit for the sake of discussion that Goldilocks inflation can be maintained continuously for long periods of time and that it does indeed give the economy a lively fillip.  The ongoing hollowing out of the middle class stands as a major impediment to the central banks' use of inflation as a stimulus for economic growth.  As income and wealth inequality increases, the middle class--and indeed much of the 99%--will obstinately resist price increases.  Inflation will remain muted and not contribute to growth.

There are plenty of reasons to be concerned about increasing financial inequality--reduced social mobility, decreased social cohesiveness, rising extremism (especially noticeable in Europe), and so on.  We can add to the list that an increasingly plutocratic society may constrain the economy's ability to grow.  And that's not good for anyone.

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