A Depressingly Simple Explanation For The Weak Recovery

Why is the economy so weak? It’s simple: Inequality. Income gains for the 95% have been meager for a long time, but up until the crisis, households could take on debt to compensate. Now credit has harder to come by, and so their buying power is limited.

Marie Schofield, Chief Economist and Toby Nangle, Head of Multi asset Allocation at Columbia Management have a great little note up reminding people of the basic force that’s holding back the economy.

For decades, the top 5% have been accumulating an ever-increasing share of the national income in the US:

The remaining 95% were only able to keep their buying power up by taking on more debt.

Lately that hasn’t been an option.

They write:

This phenomenon largely fell under the radar in the last three decades, however, as spending inequality was less pronounced and consumption trends were less affected. This dichotomy is largely explained by the powerful expansion in the supply of and access to credit for households across the income spectrum that allowed them to smooth their consumption via increased borrowing, in combination with a steady decline in savings rates over those same years. As a result, lower income households were more easily able to boost their spending until a tipping point was reached during the global financial crisis. Most studies now point to the lack of income growth for the bottom 95% of the income distribution in combination with an unsustainable rise in borrowing as a causal factor that escalated the crisis. Debt levels relative to income escalated during the same period, but more perilously for the bottom 95% (see Exhibit 2). Debt is merely borrowed spending from the future, and becomes particularly onerous if incomes do not rise in concert. A study by Cynamon & Fazzari postulates that in the recession’s aftermath, tighter borrowing standards cut off credit flows to the bottom 95% leaving them with fewer resources to maintain consumption. While household debt dynamics appear to have stabilised and deleveraging is largely complete, income inequality can continue to rise in the U.S. and consumption remain depressed because wealthier households typically save a greater share of income and have a lower propensity to spend per dollar of income. In addition, permanently tighter lending standards have left many households unable to access credit or unwilling to do so. So it is both a demand and a supply story as it relates to credit. But the main point is that income gains have been mediocre for a broad swath of middle income households for some time, and borrowing temporarily masked the demand drag. In combination these factors have been a contributing factor to the slow recovery of U.S. consumption and economic growth.

There you go. Mediocre income gains for the 95% and no easy access to credit to compensate for that. Depressingly simple.

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