Does economic inequality lead to economic stagnation due to reduced consumer spending? This is the second article in my series on the economic impacts of inequality.

The poor spend most of their incomes, while the rich spend a much smaller portion of their incomes. If income shifts from poor to rich, total consumer spending could fall. In simple Keynesian models, this would reduce the overall level of income and production.

In my previous post I noted a report on the economic impacts of inequality written by economists from Standard and Poor’s. The S&P economists devote a good deal of attention to differing consumption patterns among different income classes, but they fail to look at the aggregate data. In reality, the savings rate is not rising; the portion of income that is spent remains much higher than it was 20 or 30 years ago.

The failure of the S&P economists to look at the savings rate, charted below, suggests that they might better spend their time rating mortgage-backed-securities. Or perhaps not.

One line of thinking is that people not at the top of the income distribution borrowed money to sustain their spending, including by taking out home equity loans after their homes had appreciated. This borrowing was not sustainable and contributed to the eventual bust.

This might possible lead a reader to be confused: does inequality lead to too little spending or to too much spending? The doom and gloom crowd seems to think that it does both at the same time, with disastrous consequences.

One must also wonder if a world with more equal incomes would be devoid of overly aggressive borrowing. During the housing boom, it seems that even people who had rising real incomes over-extended themselves in the purchase of real estate. The people whom I know who overextended were not so much desperate to maintain old living standards as they were overly optimistic about their potential gains. I haven’t seen evidence that a more equal society generates less optimism at the time of economic booms.

John Cochrane has a great summary of the argument:

OK, so the idea in this report is that somehow, truck drivers in Las Vegas found out that hedge fund managers in Greenwich CT were upgrading from Gulfstreams to 737s. This made them feel bad, so they went out and took out huge mortgages that they had no chance of repaying. When house prices went up, they refinanced and bought TVs giving them even less chance of paying off their mortgages. Now they’re broke and not spending a lot. And “spending,” not productivity is the key to long-run growth. If you want to do your bit for growth this afternoon, don’t learn Python, don’t write a new app, don’t invest in a startup — head down to the mall and grab some stuff you don’t need.

I find it totally implausible that economic inequality causes reduced economic growth through reduced consumer spending, here in America or anywhere else in the world.